The majority consensus is that the USD is headed lower it's just a matter of how fast and how far. The reasons for the negative outlook for the USD include low US yields, rising US budget deficit and speculation about central bank reserve diversification. A minority of analysts suggest that the USD may continue this week's rebound. In an article written Tuesday posted on Citywire titled Why the dollar's obituary is premature author David Campbell suggests that concern about the USD loosing its reserve currency status is overblown. According to Campbell's article a shift away from USD as the primary reserve currency is impractical. Despite rhetoric from China expressing concern about the USD, China increased its purchase of US debt by 20 bln during the summer and has raised its holdings of US debt to close to $800 bln. A significant shift out of USD reserves could spark a devaluation of China's current USD holdings. Campbell notes that 62.8% of global reserves are held in USD. This creates a catch 22 for holders of USD wishing to shift out of USD reserves because rebalancing increases the risk of devaluation of current USD holdings. The Campbell article also suggests that the recent narrowing of the US current account increases the risk of a dollar shortage and that growth differential is likely to move in favor of the USD. US August trade deficit narrowed with exports rising to highest level for 2009. The narrowing of the US current account means there will be fewer US dollars floating around. US GDP is likely to post stronger growth into 2010 supported by aggressive US fiscal and monetary stimulus and weaker USD. Weaker USD has helped to fuel US export growth and will contribute to improvement to the outlook for US GDP. US Q3 GDP will be released Thursday and is expected to post a big gain. In contrast, EUR strength is a major headwind to the EU recovery because the EU economy is highly dependent on export growth.
Another positive for the USD may be that the recent rally in stocks and risky assets has reached a peak. MarketWatch reported Wednesday that the managing director of Pimco, Bill Gross sees all assets as currently overvalued and he looks for a top in risky assets. Gross believes that countries are relying too much on asset appreciation and not enough on increasing the production of goods and services. The current USD rebound reflects a 5% decline in global equities and a drop in risk appetite which has dampened demand for higher yield assets and encouraged safe haven flows to the USD. The USD had been weakening since late March when global equity markets bottomed and recently traded at a 14 month low. Part of the USD decline reflected improving risk appetite as equity markets experienced a significant rally. Ultra low US interest rates are another reason for the USD decline. It is now cheaper to borrow in USD than JPY and the USD has emerged as the primary global funding currency. Because of the USD's status as the funding currency USD price moves have become even more closely correlated to the direction of equities. Fund manager Jim Rogers says that the rally in the USD may last a while as equity and commodity markets correct. Roger's also noted that there too many USD bears. A more ominous prediction that the markets are nearing a peak comes from NYU economist Roubini. Roubini says that USD carry trade is fueling another huge asset bubble. The key question for USD outlook is whether investors will look to buy the recent 5% correction in equity markets or increase liquidation of stocks and riskier assets. The timing of withdrawal of fiscal and monetary stimulus will likely determine the answer to this question.