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The currency market is currently running on two different views, but both are pointing to dollar weakness in the medium to longer term.

The first outlook is that the economy is starting to recover, or just initiating the expansion period. This view is fueled by the recent releases, which point out that consumers are actually holding strong.

TheLFB-Forex.com Trade Team said that, when the awful first quarter numbers were printed, the financial markets found strong support in the fact that consumer spending increased during the first three months of the year. Yesterday, a report showed that consumer confidence increased at a record pace in April and May, which are the first two months of the second quarter. This made investors optimistic once again about the global recovery theme, and furthermore made some investors bullish. According to TheLFB-Forex.com Trade Team, the U.S. economy might be on the path to recovery by the second part of 2009. 

As the U.S. and global economies recover, institutional traders become more risk-tolerant, meaning that they will abandon the safety of the U.S. dollar for the yield of foreign assets. This should empower the euro and the rest of the major pairs, in the long run. If this holds true, some are saying the euro might break the 1.6000 by the end of the year. 

The other important view that is influencing the currency market is that the global economy is heading towards a period of massive inflation in the next few years. This outlook is fueled by the fact that the U.S. government is running a huge deficit, by the ultra-low level on the Fed Funds and by the huge size of the Fed’s balance sheets. All three taken individually are known to spark massive inflation in the medium to long term (around two years), but now these three forces are working together. 

A good way to gauge inflation expectations is to calculate the breakeven level between Treasury notes and similar maturity TIPS notes. Both the spread between 5-year and the 10-year notes increased at a record pace since March, when the equity rally first started.  

In periods of high inflation, the greenback looks rather weak. This happens because investors are looking for ways to beat inflation by investing in foreign denominated assets (especially those of emerging economies), and in commodities.

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