Betting on the dollar in 2012

@CNNMoneyInvest December 29, 2011: 9:37 AM ET
dollar, euro, currencies

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NEW YORK (CNNMoney) -- Scott Boyd is a currency analyst with Toronto-based foreign exchange trading firm OANDA.

That sound you hear is the collective sigh of relief as we put the wraps on yet another difficult year.

OANDA, MarketPulse
Scott Boyd is a currency analyst with OANDA and contributes to the company's MarketPulse FX blog.

The respite may be brief, however, and by the time 2012 comes to a close, we could well be yearning for the good ol' days of 2011.

Compared to this time last year, the U.S. economy is ending 2011 on a reasonably positive note. Gross domestic product -- the broadest measure of the nation's economy -- expanded in each of the first three quarters of the year reaching 1.8% growth in the third quarter.

Early indications suggest the economy continued the trend in the final three months of the year.

For the month of November, unemployment fell to the lowest rate for the year, declining to 8.6% from a high of 9.2% in July.

Despite these modest improvements, there is little reason to expect any tightening of the Federal Reserve's policy for the new year.

Fed Chairman Ben Bernanke continues to warn of slowing growth and as recently as late September referred to unemployment as a "national crisis".

A rate hike at this time could constrain spending and lower growth opportunity even further.

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The adherence to the current interest rate means the dollar will not benefit from an increase in demand that typically results when yields move higher following a rate hike.

While the U.S. continues to face challenges within its own borders, should the recovery stall in the coming year, the seeds for that reversal are likely being sown currently in Europe.

Christine Lagarde, managing director of the International Monetary Fund, told an audience at the U.S. State Department in mid-December that "there is no economy in the world immune from the crisis that we not only see unfolding but escalating".

Bernanke echoed this same sentiment following a closed-door meeting with a group of senators. The Fed chief was forthright in his view that the weaker outlook for Europe would have a greater negative impact on the U.S. economy than originally expected.

These comments only confirm what is already painfully obvious -- the eurozone debt crisis has entered a new, more potent phase. Recent events show beyond any doubt that the debt contagion is spreading well beyond Greece and even the region's larger economies are now at risk.

Spain, Italy, and most alarmingly, France have no choice in the coming year but to slash current spending levels to reduce deficits. Failing to act decisively will only lead to questions on the ability of some of these countries to remain solvent.

Further complicating the issue is that the region is expected to experience slower growth in the coming year. In fact, INSEE, France's official statistics agency, released a report in December claiming that France had already descended into a recession with no relief expected until the middle of 2012.

The report predicts that France, the eurozone's second-largest economy, will shrink 0.2% in the final quarter of 2011, with a further loss of 0.1% in the first three months of 2012.

That bodes well for the U.S. currency. Demand for the dollar could increase in the new year as uncertainty abounds for the euro.

Heading into the end of December, the euro was hovering around $1.30, having twice touched $1.29 during the month -- a level not seen since mid January, when Japan pledged to buy eurozone bonds to help stem Europe's debt crisis.

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Should the euro continue to decline, euro selling will likely increase dramatically as investors abandon the euro in favor of a more stable currency.

Much of this money will find its way to the dollar. In fact, this "flight to safety" has been going on for some time now and it was only half a year ago that the euro was worth nearly a dollar and a half.

Those days appear to be gone and some analysts are suggesting that parity between the euro and the dollar is not out of the question.

-- Scott Boyd also contributes to OANDA's MarketPulse FX blog. To top of page

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