[LFX]

The broad market outlook for the USD remains to look for short-term negative pressures, but a recovery in 2010 against G10. The link between positive risk sentiment and a lower USD has been strong and traders do not expect it to disappear immediately.

Near term positive growth news should continue to imply a USD-negative dynamic. USD weakness is, however, already prompting further currency discussion from policymakers overseas, as foreign currency strength is proving painful at the macro level. While initial comments were more out of the political side, we have been recently hearing more commentary from central bankers, including ECB officials. Policymakers in commodity producing countries have been particularly vocal. Concerns over recent currency strength against the USD are starting to influence monetary policy decisions in Norway, Canada and New Zealand. This rhetoric also reflects the view that previous G10 foreign currency strength is laying the groundwork for its own demise because of the damage it does to those economies.

[LFX]

The core of the expectation for USD recovery in 2010 against G10 is that the risk positive/ USD-negative relationship will diminish next year. The key driver for this phenomenon has been the rebalancing of EM FX reserves. Investors have been returning to EM and commodities since risk appetite stabilized in March and, consequently, foreign central banks have experienced a surge in FX reserve growth that has required significant rebalancing sales of USD. Ultimately, analysts expect FX reserve accumulation to slow next year as capital inflows to EM taper off and EM nations embrace greater FX flexibility.

[LFX]

The medium-term US outlook is another reason why some look for a stronger USD in 2010 against G10 and stay skeptical about the possibility of a USD crisis. Some Market Economists expect USD growth next year to outpace growth in the Euro Area and the UK. While capital flows have gone outside the US this year as the worst of the financial crisis subsides and risk appetite revives, analysts expect that markets will ultimately stop punishing USD for an improving US macro outlook.

The core basis around much of the longer-term USD negative sentiment is a belief that the fiscal and monetary response to the crisis will ignite inflation and debase the USD. However, there is still little evidence for these fears, as actual inflation remains negative and inflation expectations are relatively stable after recovering from their crisis related nadir. Meanwhile, market economists expect core inflation to decline throughout 2010 as labor and product markets fail to generate much price pressure.