As indicated in our research towards the end of 2004, we were expecting a significant bounce in the US dollar towards the end of 2004, into the beginning of 2005. This has clearly occurred. On one measure, the US dollar has bounced 4.5% from its 2004 low – within our initial expectation for 3-5%. The question now is whether this bounce has nearly concluded, or does it have much further to go?

The fundamentals remain very similar. Interest rates are rising in a measured fashion, despite scares that the Fed will accelerate the pace of tightening. Meanwhile, the US current account deficit remains large and is likely to grow further in the near-term. This means the US needs huge flows coming into the country to support the US dollar. The main providers of these inflows have been Asian central banks. This is unlikely to dry up totally although if, as we expect, China allows greater currency flexibility in 2005, then the flow may slow somewhat, undermining support to the dollar.

The big unknown facing global currency markets is the impact of the American Job Creation Act, which includes a temporary incentive for companies to repatriate foreign profits back to the US. The government estimates that this could bring back USD 100-150bn into the country, funding almost a quarter of the annual deficit.

This is clearly significant and could help prop up the dollar. Therefore, we believe that there are still upside US dollar risks in the shortterm. However, the medium term outlook for US dollar weakness remains intact.