How Much Longer Can U.S. Dollar Appreciate?

The U.S. Dollar has been appreciating rapidly after a sudden acceleration of the global financial crisis. What is behind this move and how much longer the currency can sustain its current level?
Anna Fedec, 3/3/2009 11:29:08 AM

At the beginning of the last year we were arguing that the U.S. dollar could lose its position as the most popular reserve currency in favor of the Euro. But in the second quarter of 2008 the dollar suddenly started to rebound and began one of its biggest rallies in years, going from 1.6 to 1.2 dollars per euro in only three months.

Indeed, back in 2006 and 2007, several countries were considered to be in much better economic condition than the United States. For example, in that period the Euro Area economic growth surpassed that of U.S. and as a result, international investors were more willing to hedge dollar exposure with investments into the Euro Zone. Moreover, even though some economic slowdown was becoming visible in the United States, the majority of economists believed that the slump would be short and there would be no chance of spilling over to other countries. However, few months later the situation changed drastically, and the underestimated slowdown in the U.S. economy was soon transformed into a major global recession. More importantly, as everyone was being hit by recession fears, the U.S. dollar was once again seen as a safe haven currency, supported international demand for U.S. government securities.

Even so, at Trading Economics we think that current safe heaven position of the U.S. dollar could be temporary.  For some time, the U.S. economy has been running a current account deficit and the bill for biggest fiscal stimulus plan in the U.S history could bring the U.S. financial debt to the world very close to unsustainable levels. In fact, with the Japanese and Chinese economies also fighting with the global economic slowdown, one should not be is the yields on U.S. treasuries rises to unprecedented levels, making the fiscal stimulus more pricey than previously estimated.