Month: +3.76% Quarter: +0.89% YTD: -4.06%

The trade-weighed U.S. dollar index fell to its lowest level in 15 months late in the fourth quarter, broadly undermined by improving appetite for riskier assets and the view that U.S. borrowing costs will remain exceptionally low for an extended period of time. Mounting U.S. fiscal deficits added to the greenback's broadly heavier tone, as did persistent questions regarding the dollar's status as the world's reserve currency. The global flood of liquidity fueled by historically low lending rates and the printing of money by various central banks encouraged investors to sell low yielding dollars to buy commodities, equities and emerging market currencies.

Additional signs of stabilization in the global economy fueled appetite for riskier - trades that were often funded by borrowing and selling the low yielding USD. Ultra-accommodative monetary policy in most of the industrialized world along with central banks' printing of money flooded markets with liquidity that found its way into assets in emerging markets like Brazil and China. While concerns about the greenback's longer-term reserve status weighed, the outlook for near zero percent Fed lending rates remained the man drag on the dollar, especially against it higher yielding counterparts. Profit taking and improving optimism about a U.S. recovery helped the greenback regain its footing late in the quarter.

	Outlook The greenback will continue to face an uphill battle in the moths ahead as no expected change in the Fed's ultra-accommodative monetary stance will leave the U.S. currency vulnerable to additional selling in favor of higher returning assets. Still elevated optimism about a global recovery should keep risk appetite elevated and undermine lower yielders like the greenback. However, as the Fed begins to signal that it is closer to normalizing policy, likely sometime in H2 2010, the dollar should appreciate. Such a scenario would see positive U.S. economic data translate more positively to the outlook for Fed monetary policy and benefit the USD. Elevated global recovery expectations could prove overly optimistic as the effect of governments' stimulus faces in H2, a scenario that favors a reduction in risk appetite and likely, a stronger dollar as well. Nagging deficit and reserve status worries should keep the dollar's upside somewhat limited.
	Positive Factors • The U.S. dollar's status as the world's safe-haven currency continues to provide it with support, especially during periods of increased aversion to risk and economic or financial uncertainty • Signals that the Fed is getting closer to eventually normalizing its ultra-accommodative monetary policy should help improve the yield appeal of USD-denominated assets and lead to more sustainable gains for the greenback • The rally in risk assets since March, which was fueled by upside surprises to economic data and improving sentiment, appears to be pricing in an unrealistic pace of global economic recovery. A pullback in risk appetite would favor safer assets like the USD • The Federal Reserve has signaled that it intends to unwind various credit easing facilities in the months ahead. The removal of policy accommodation is inherently USD positive • While the unemployment rate continues to rise, the pace of monthly job losses has fallen sharply from its peak last winter • Rising Treasury yields and LIBOR rates makes funding carry trades in higher yielding assets with the dollar slightly more expensive • The Obama Administration's massive stimulus spending, while detrimental to America's fiscal position, is widely seen as contributing to positive, albeit short-term economic growth
	Negative Factors • Signs of stabilization in the global economy suggest that recovery is gaining traction gradually. The resulting improvement in risk appetite favors higher yielding assets, usually at the expense of the USD • Zero percent interest rate policy and a flood of dollars into the financial system as a result of the Fed's quantitative easing are inherently USD-negative and markedly deteriorate the U.S.'s already dire fiscal position • Low U.S. lending rates and improving risk appetite incentivize traders to borrow and sell the greenback against higher yielding assets like stocks, commodities and emerging market assets • Soaring government spending and deficits and the required debt issuance to fund them threaten the U.S.'s fiscal outlook and weigh on foreign demand for USD-denominated assets • The removal of policy accommodation globally will prove to be a very delicate procedure. Political pressure could delay the timely removal of policy accommodation and result in significant inflationary pressures • The recent call of the G20 for a rebalancing of the global economy implies a need for a broadly weaker U.S dollar • Rising unemployment, now at its highest level since 1983, threatens to keep aggregate demand in the economy under increasing pressure, even as other sectors recover. The Fed is unlikely to rise rates in an environment of rising unemployment • Mounting talk of central bank reserve diversification out of dollar assets remains a key liability for the greenback
	Conclusion The fourth quarter of 2009 marked a continuation in the U.S. dollar's longer-term downward trend. After starting 2009 off in broadly positive territory, the dollar succumbed to selling pressure and fell to a new 15-month trade-weighted low late in Q4. During the height of the global financial crisis, the dollar benefited from the market's extreme aversion to riskier assets likes stocks, commodities and emerging market currencies. The wide-scale flight to safety pushed the U.S. currency to a three-year high against a basket of its major counterparts in March, the peak of financial market bearishness. However, since then, the dollar has suffered as investors became more and more optimistic that the worst of the crisis has passed. The resulting rise in risk appetite saw investors abandon defensive dollar assets in favor of riskier, higher returning investments abroad. That trend was encouraged by the greenback's near zero percent interest rates, improving optimism towards emerging market assets, and the flood of global liquidity, which kept hard assets like commodities in high demand. Persistent worries about America's gaping fiscal deficits and the dollar's status as a global reserve currency added to the broadly negative sentiment that undermined the U.S. dollar. Global economic data, while mixed, pointed to continued improvement in underlying fundamentals in the fourth quarter. PMI manufacturing data turned positive in the U.S., the euro zone, the U.K., Japan and China. Services sector activity in the world's largest economies also improved markedly over recent months. Overall gauges of global trade have shown that activity likely bottomed last winter. Various metrics of business and consumer sentiment too have improved markedly over recent months, an encouraging indicator that economic activity will likely pick up further in the coming months. The U.S, the euro zone and Japan all emerged from recession in Q3 by posting mildly positive growth. Finally, while unemployment rates in most of the industrialized world are still rising, the pace of job losses has slowed significantly from last winter's peaks. The seeming improvement in much of the world's economies, albeit at still depressed levels, has encouraged investors to take on more portfolio risk in the form of stocks, commodities and increased exposure to emerging markets. The continued unwinding of defensive USD-denominated positions accumulated at the height of the crisis remains a key driver of the greenback's broadly downbeat tone. Indeed the broad-based signs of stabilization in the global economy have been encouraging. However, many questions about the sustainability of the pickup in activity remain unanswered. Much of the improvement in the global economy has been fueled by trillions of dollars in various governments' stimulus plans, unsustainably low global lending rates, and the printing of money by the Fed, the Bank of England, the ECB and the BOJ. America's cash for clunkers and the first-time homebuyer's tax credit, for example, were hugely successful in sparking near-term activity in the troubled housing and automotive sectors. However, the schemes have done little more than bring forward demand for goods, or robbed from future demand for current consumption. In other words, the boost in activity as a result of the stimulus is likely unsustainable and could be followed by a significant drop in activity once the government spending winds down. Similar programs in the U.K., the euro zone, Japan, China and Australia have all been credited with spurring activity in their respective economies. Again, while encouraging, the resulting rise in output is unlikely to be sustained once the stimulus has been removed. Moderation in global growth in the second half of 2010, once the crutch of government stimulus is gone, will weigh on risk appetite and could provide the dollar with renewed safe-haven demand. China in particular, which is often touted as the next engine of global economic growth, is vulnerable to a slowdown if its massive buildup in capacity is unable to find adequate demand, either domestic or global, in 2010. The greenback's recent slide could also loose steam once positive economic data begins to finally translate into a higher chance of Federal Reserve monetary policy normalization. The Fed as long maintained that lending rates in the U.S. will remain "extraordinarily low for an extended period of time", an outlook that leaves the greenback vulnerable to selling, especially against its higher yielding and riskier counterparts. Investors have actively borrowed USD and invested in emerging market assets and commodities- so-called carry trades. However, the Fed can not maintain its ultra-accommodative policy stance indefinitely. As economic recovery gains traction, inflation will increasingly become a key source of worry for both market participants and policymakers. While no change in the Fed funds rate is likely until late in 2010, the Fed will begin to more seriously lay the groundwork for policy tightening well before that time. The greenback should find increased support from the improving yield appeal of USD-denominated assets relative to their counterparts overseas. The improved outlook for the dollar is not however, without considerable risk. Soaring government deficits and the required debt issuance to finance them remain a key threat to the dollar's longer-term stability. Global investors could easily shun U.S. government debt amid a backdrop of unchecked spending and borrowing from Washington or demand higher yields in return for financing. Soaring fiscal deficits also raise doubts about foreign central banks' willingness to continue investing their currency reserves in dollar assets. However, the "short US dollar/ long stocks, commodities, emerging markets" trade has become extremely overcrowded and appears to be pricing in an unrealistic pace of global recovery. While the dollar's long-term headwinds will likely keep its upside somewhat limited, its near-to-medium-term prognosis will likely prove more optimistic than its performance in most of 2009 would suggest.