2010: Year of the dollar?

chart_dollar.top.gifBy Paul R. La Monica, editor at large

NEW YORK (CNNMoney.com) -- Happy New Year indeed! The financial markets got off to a hot start on the first day of trading Monday. Name an asset and it likely went up.

Stocks? Check. Gold? Still shining bright. Oil? Gushing higher. Treasury bond prices? Affirmative. The dollar? Eh ... not so much.

The U.S. Dollar Index (DXY) rose in December along with the stock market. That could be a sign that investors now view good economic news as good for the dollar too.

The greenback had a rough 2009, dropping 4% against a basket of six other major global currencies. And even though the U.S. economy is showing signs of life, some fear the dollar could fall further.

The most pressing concern is that the trillions of dollars pumped into the financial system by the federal government. Its impact on the ballooning budget deficit is bad news for the dollar.

The dollar is currently hovering at roughly $1.44 against the euro -- about 10% stronger than the all-time low it hit in July 2008.

Yet, some currency analysts said they don't believe the dollar will reach a new low. In fact, some think the slide may soon be over.

The trading in the dollar last year was largely about the tolerance of risk. Investors embraced the dollar when the global economic outlook seemed bleakest due to a notion that the greenback was likely the safest currency in town.

But once stocks around the world and commodities such as oil and gold took off on recovery hopes, investors fled the dollar for sexier returns.

That may be changing.

Vassili Serebriakov, currency strategist with Wells Fargo in New York, is predicting better times ahead for the dollar because the economy is likely to improve.

He said that investors may finally get out of a trading mode and focus more on long-term fundamentals. And that means that good economic news should be viewed as good news, not bad, for the dollar.

"Through most of 2009, there was an inverse correlation between the dollar and stocks. When stocks went up, the dollar went down. That's not entirely intuitive," Serebriakov said. "But the dollar's performance in 2010 could depend on the strength of a recovery. If a recovery is stronger, the dollar will do well."

But what about the whole notion of the dollar not being risky. If the dollar moves up, does that mean a big sell-off in stocks and commodities is looming? That may not be the case.

Andrew Busch, global currency and public policy strategist at BMO Capital Markets in Chicago, pointed out that December may have been a turning point for the dollar. The dollar gained ground against other currencies during the month even as stocks continued to surge.

Busch said that it is telling that the dollar finally started to move up on good economic news. He believes that the reason for this is that there is a growing sense that the Federal Reserve may look to unwind some of its lending programs over the course of 2010.

As I pointed out in Monday's column, some even think that Federal Reserve chairman Ben Bernanke and the rest of the policy-setters at the Fed may even begin to modestly raise interest rates toward the end of the year.

"The nice dollar rally through the end of last year was due to shift in expectations about the speed of a U.S. exit strategy from its easing programs. That will likely continue," Busch said.

But Busch quickly added that unless Bernanke or other Fed members start to strongly signal that rate hikes are really in the cards, the dollar could wind up slip sliding away again. (Apologies to Paul Simon for using your song title in something as mundane as a currency story.)

"The fate of the dollar is in the hands of Ben Bernanke. If he begins the exit process and starts to raise interest rates, the dollar will perform okay this year," Busch said.

Dan Cook, senior market analyst with IG Markets in Chicago, said that he's also expecting the dollar to fare better this year. However, he's not convinced that the days of the dollar being considered a safe haven are over just yet.

Cook said that the labor and housing markets still remain weak, which could keep the Fed on the sidelines for a while longer. And if that's the case, Cook said the rally in stocks could fizzle out and investors will flock back to the dollar.

"The employment situation is still terrible. So more dollar strength could be driven by negative economic news," he said.

Either way, currency analysts are predicting a rebound for the dollar. So just how much stronger could it get? Serebriakov is forecasting that the dollar will end 2010 at about $1.32 against the euro, which would be about 8% stronger than current levels.

Still, Busch said that other currencies may fare better against the dollar. He pointed out that any country that has heavy exposure to oil, gold and other hot commodity markets, such as Canada and Australia, could gain against the greenback.

And at the end of the day, Busch said that trying to predict the direction of the dollar and other currencies -- especially in such a dynamic time for the global economy -- is extremely difficult.

"The currency market is really messy. Sometimes it makes sense and sometimes it doesn't, but at some point in 2010 the currency markets will make everyone look rather foolish. That's what they do," he said.  To top of page

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