The dollar's many detractors may have missed it, but the much-maligned U.S. currency is on rise. The greenback, thought to be on life support and mostly surviving on safe-haven flows, hit bottom three years ago and is now in a long-term recovery.
The dollar has been climbing since it struck record lows against the euro in July 2008, helped recently by the euro zone debt crisis, an improving U.S. economy and a return to the dollar as the reserve currency of choice.
The U.S. economic recovery alone is expected to push capital flows into the dollar. If growth does take root more firmly, it will reduce bets on more monetary easing, which has been a debilitating weakness for the dollar since the 2008 financial crisis.
The market is starting to agree in a way that it hasn't in nearly a decade. A key factor that points to more dollar strength can be found in the options market, where bets on the dollar's path against the yen is closer to favouring the dollar more than at any time in at least nine years.
"The deck is stacked, at least at the present, in our favour," said Jacob Gold, president of Scottsdale, Arizona-based Jacob Gold & Associates Inc., an investment strategy advisory firm for high net-worth individuals and companies.
Though up 13.6 percent from the trough in 2008, the ICE Futures U.S. dollar index is currently closer to that bottom than its peak, suggesting more room for improvement. It was last trading at 80.305.
With the euro, which comprises 57.6 percent of the index, expected to fall to $1.20 US in the next several months, according to Barclays, GAM and other firms, from the $1.2915 it trades at today, the index is bound to move higher. The euro has lost 19.5 percent since its last peak in 2008.
The six-member dollar index, composed of the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc, troughed at 70.698 on March 17, 2008 as the euro was testing its peak.
"When you compare our country's value, relative to others, we are overwhelmingly better positioned economically than others," Gold said.
NINE LONG YEARS
Dollar investors received a significantly bullish signal in the options market in recent weeks.
Dollar/yen three-month risk reversals traded close to neutral after nine years of being biased to dollar puts, or the right to sell dollars, and yen calls, the right to buy yen.
The dollar/yen three-month risk reversal was last at -0.325 on trading platform GFI after moving steadily down from a trough of -2.63 in July last year. It has been biased in favor of the yen since at least the third quarter of 2003, using DailyFX data.
"A lot of people are positioning for either dollar/yen stabilization or a fairly big bounce in the dollar/yen," said David Rodriguez, quantitative strategist at DailyFX in New York.
The options play may be a specific sign few want to bet against the very deep pockets of the Bank of Japan, which is determined to keep the yen from rising.
International foreign currency reserves data also points to better days for the dollar despite rhetoric in recent years about finding alternatives to the greenback.
The International Monetary Fund's Currency Composition of Official Foreign Exchange Reserves data shows the dollar's share of known global currency reserves rose 1.9 percent in the third quarter over the second quarter to 61.7 percent, while the euro's holdings were down 0.9 percent to 25.7 percent from a year earlier.
The dollar comprised 62.1 percent of known reserves as late as the second quarter of 2010 before falling to 60.2 percent in the second quarter of 2011. Now it's again rising, indicating higher dollar demand that will lift the U.S. currency.
"It was Mark Twain who remarked that 'stories about my death have been exaggerated'," said Alan Ruskin, head of G10 currency strategy at Deutsche Bank in New York. "The same comment will apply to the U.S. dollar's reserve currency role."
Other countries appear unenthused about assuming a bigger role as an international reserve, especially if it means export-damping currency appreciation.
Many thought the euro would rival the dollar as the world's reserve currency, but that notion faded in the face of fears that the euro zone's days might actually be numbered.
Japan and Switzerland have made clear they will not tolerate further appreciation in their currencies, traditionally seen as safe havens.
The Swiss National Bank imposed a floor on the euro/Swiss franc at 1.20 francs which also keeps the Swiss franc weak against the dollar. The Bank of Japan intervened heavily against yen strength on October 31 when the dollar hit a record low against the yen.
China's yuan has been allowed to slowly appreciate against the dollar and the Middle Kingdom may have goals that include the yuan becoming a reserve currency. But there are still too few currencies that are convertible against the yuan, and its moves are tightly controlled by Chinese authorities.
Though the dollar's record lows came before the euro-zone debt crisis erupted, it is difficult to ignore the effects of Europe's troubles in aiding the greenback's resurgence.
For several years, investors saw the dollar mainly as a safe haven currency to be bought in times of uncertainty, but rock-bottom U.S. interest rates meant they abandoned the greenback when they began to feel more optimistic about global growth.
Now that correlation has broken down and positive U.S. data has led both the dollar and U.S. stocks higher. Ultimately, a currency has to be supported by fundamentals, and here the United States appears to be improving. The jobless rate has dropped to 8.5 percent after a 10 percent peak in October 2009.
"As the economy recovers and the Fed's attention switches to the risk of inflation, the perception may grow that the U.S. will be first of the major economies to begin to raise interest rates which, again, would prompt support for the dollar," said Mike Franklin, investment strategy head at Beaufort Equity in London.
And then there's Europe.
Growing pessimism about the ability of European officials to agree on a permanent solution to debt problems plaguing the region has prompted a heavy sell-off in the euro in past months.
Even if things stabilize, a durable solution still appears far off, and doubts are likely to remain.
"The major concerns of 2011 have rolled over into 2012, with fiscal austerity and the sustainability of the euro project heading up the list," said Adrian Owens, Investment Director at GAM in London who managers some $2 billion and sees the euro heading to $1.20 this year.