The US dollar is now receiving support from the US monetary policy outlook. Federal Chairman Alan Greenspan's testimony in July showed confidence in the sustainability of US growth. However, the US current account deficit remains a threat to the US dollar.

The Euro may be challenged by the US dollar recovery. However, the modest reform efforts in Germany and France that improve labour market productivity is providing support for the currency.

The Japanese Yen (JPY) is undervalued given the current state of economic fundamentals. The Japanese economy is recovering, but the JPY is finding it hard to appreciate in the backdrop of higher oil prices. This has forced us to revise up our year-end USD/JPY forecast to 103, although this still implies a significant JPY appreciation over the next 4-5 months.

Similarly, Asian currencies are also experiencing weakness due to their sensitivity to high oil prices. Our current outlook for continued strength in oil prices has also led to a revision of the Asian currency forecasts, but we maintain a long-term view of Asian currency outperforming against the US dollar.