APRIL 1, 2010.

Dollar Revival Gains Pace

Euro's 2010 Slide Boosts the Buck; Curious Yen Strength.

By TOM LAURICELLA

After almost being given up for dead last autumn, the dollar continued to revive in the first quarter, extending a rebound begun during the final weeks of 2009. And although the greenback's gains were uneven, the foundation may be set for the U.S. currency to make a broader run higher.

"The theme in the first quarter was fiscal irresponsibility," said Kathy Lien, currency strategist at GFT Forex. "But in the second quarter I'd expect a lot of the fiscal concerns will subside. We're going to see central banks laying the groundwork for … lifting interest rates and that's going to benefit the dollar."

Much of the greenback's better tone during the period came at the misfortune of the euro, as the debt crisis in Greece dragged on and European Union officials haggled for weeks over a solution. Also weighing on sentiment for the common currency were concerns that heavily indebted Portugal and Spain could be the next dominos to topple. The euro slid 6% in the first quarter to $1.3509, marking an 11% decline from its peak last November.

While the Greek plan that EU officials ultimately agreed on last week is seen as safety net against the risk of default, many believe that Europe is likely to be in for an extended down period. Slow economic growth and low interest rates are expected as the Mediterranean countries are forced to clamp down on government spending.

"There's a massive adjustment which has to happen," said Sebastien Galy, currency strategist at BNP Paribas. BNP has for some time been calling for the euro to fall below $1.30 this year and head toward $1.20 by the end of 2011. In the wake of the EU plan, "we see $1.20 happening increasingly fast," he said.

It wasn't all up for the buck in the first quarter. Despite a deeply troubled Japanese economy and even some comments from the new Japanese finance minister suggesting that a weaker yen would be helpful, the dollar rose just 0.44% against the yen, ending at 93.49.

"The fundamentals are so bad in Japan," said David Gilmore a partner at Foreign Exchange Analytics, that the yen's resiliency "defies logic."

Mr. Gilmore and others say the repatriation of investment income by Japanese investors is a likely reason for the currency's buoyancy. But as the quarter wound down, the yen weakened as the Bank of Japan took additional steps to pump money into the country's financial system.

In the U.S., by contrast, the final day of the quarter saw the Federal Reserve take a major step to reverse its unprecedented loosening of credit as it ended its support of the mortgage-backed securities market. A growing number of analysts expect the Fed to soon lay the groundwork for raising interest rates, which would underpin the dollar further.

Against emerging-market and commodity-producing countries, the dollar also struggled in the first quarter. The Brazilian real fell 2%, and the Canadian dollar gained 3.51% as it approached parity with the U.S. for the second time since 1976.

But with central banks in Australia and India raising interest rates, and Brazil and Canada seen likely to follow, some analysts think those currencies could lose support in coming months if it appears their economies could appreciably weaken.

The strength in such currencies "has been a growth story and as they tighten policy, people are going to be less comfortable staying in those markets," Mr. Gilmore said. In part, those currencies rose on the back of money heading into those countries' stock and bond markets. That, Mr. Gilmore said, could lead to a "considerable pullback" and a stronger dollar.

In some ways, it will simply be a reversal of 2009's trends, Mr. Gilmore says. "If you believed that the liquidity provided to markets helped inflate asset prices … and got people to buy risky currencies then it follows that when the central banks pull back, those asset prices are going to correct and those risky currencies are going to weaken" against the dollar, he said.

Much of what happens in the big commodity-producing countries and broadly in the foreign-exchange arena will depend on a currency-market wildcard: China, whose currency has been effectively pegged to the dollar since Beijing halted the gradual appreciation of the yuan in mid-2008.

China is widely forecast to start raising interest rates in coming months to cool its fast-growing economy. That could hurt demand for raw materials and weaken so-called commodity currencies like those of Australia and Canada. China also is being pressured by U.S. officials to allow the yuan to appreciate against the dollar, which some think could happen by year's end despite diplomatic wrangling. That in turn would make its exports more expensive abroad and possibly lend a prop to the dollar and rival Asian currencies.

For the most part, the expectation is that China will trim economic growth but not stamp on the brakes. "They're going to be very cautious," said Paul Robinson, a currency strategist at Barclays.

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