U.S. Dollar Rebound – Can it last?

USD has rebounded, but it’s now a little concerned about the sustainability of the USD at these levels.
The fair value model suggests no further major decline is needed and indeed, the USD could
weaken as the deficit funding task escalates and the recession undermines investor confidence.
If commodity prices lose further luster, it will be positive news for the U.S. economy and USD,
although in recent weeks, the link between commodity prices and the USD has weakened.
Of note, there has been some narrowing in the international trade deficit since 2006.
As mentioned, exports have been strong on the back of what was a solid growth performance in the rest of the world, the prior USD weakness helping on this front; while import levels have been moderating in reaction to the cooling in domestic demand and the weakness in business investment.
A further narrowing in the trade deficit is likely over the medium term.
The U.S. budget deficit is poised to widen dramatically as the combined effects of the weak economy, TARP measures and other fiscal loosening impact on government finances.
There is a reasonable longer run link between the deficit and the USD.
The U.S. has traditionally relied on foreign savings to fund the budget deficit (unlike Japan for example). This has meant that either higher yields or a ‘cheaper’ USD are necessary to attract foreign flows.

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