Looking at the US economy in isolation, the dollar outlook is certainly not encouraging as it will remain weighed down by fears over reserve diversification and rising government debt. If the perspective widens to the global economy, then the outlook looks more encouraging. The European economies will under-perform while fears over a lack of sustainability in the global economy are also liable to increase. In this environment, there should be only limited net capital outflows from the US and the dollar will also gain support on valuation grounds. Overall, the dollar should strengthen against the Euro early in 2010, although probably for the wrong reasons.

The US economy will continue to expand early in 2010 with momentum carried over from late 2009 as consumer spending recovers while confidence has also improved and the labour-market deterioration has eased.

It is still very unlikely that there will be a strong and durable recovery given huge problems surrounding consumer debt and credit availability. The continuing contraction of credit is a very important indicator of underlying stresses. Although the administration will continue to target support for the housing sector, overall fiscal policy will be much less supportive during the year.

The Federal Reserve will be able to gradually withdraw the highly-expansionary monetary policy and quantitative easing, but it will be very difficult to sanction a significant increase in short-term interest rates. Although longer-term yields are more important for currency direction, it will still be difficult for the US currency to secure strong support on yield grounds.

The dollar outlook is generally positive on valuation grounds with the currency under-valued on a medium-term perspective.

The overall US fundamentals will still be weak and there will be expectations of longer-term flows away from the currency. With central banks under pressure to diversify currency reserves away from the dollar, this will increase the pressure for private-sector flows into the US.

The attitude of US investors will be extremely important. If they scale-up purchases of overseas assets then the dollar could be subjected to heavy selling pressure. If US investors are more cautious and there is significant capital repatriation, then the dollar could gain firm support.