Where does the dollar go from here?
Factors supporting the dollar:
U.S. GDP - The economy contracted by a less-than-feared one percent in Q2, as the interventions in housing and banking, re-liquefied credit markets, and fiscal stimulus appear to have put a floor under commercial activity. If the recession has bottomed, and business investment, exports, housing demand, and consumer demand increase, the U.S. will vector toward a decent-sized recovery. That would increase the attractiveness of U.S. investments, boosting the dollar.
U.S. Budget deficit - Don't look now, but the U.S. Treasury just announced an improvement in the U.S. fiscal status. No joke: for the first time in more than two years, the Treasury's forecast borrowing requirement - basically what it needs to borrow to pay the U.S. government's bills - declined to $406 billion for the government's fiscal Q4 (July-to-September), from the previous estimate of $515 billion. If that trend continues, lower inflation and (eventually) a smaller supply of dollars globally will result, supporting the dollar. Major U.S. debt holders China, Japan, and Saudi Arabia will certainly cheer that, as it would make it more likely the purchasing power of their dollar-denominated investments will maintain current values.
U.S. trade deficit - Also encouraging is the flow of wealth. After a nearly five-year period of unsustainable U.S. trade deficits, the nation's trade deficit is falling, down to $25.96 billion in May. U.S consumer spending cutbacks have collapsed imports, and U.S. businesses are holding-their-own, even in the recession, regarding foreign sales. In addition, oil's plunge from sky-high prices near $150 per barrel during the leveraging bubble also has decreased the trade deficit. If the U.S. can eliminate the deficit and start running trade surpluses, its wealth will increase, boosting funds available for investment - and that's always a good sign for a capital-needy, entrepreneurial economy like the U.S.
Factors weighing on the dollar:
The national debt - True, the U.S. budget deficit forecast has narrowed, but the nation nevertheless is likely to emerge from the recession more than $12.1 trillion in debt. By the end of 2010, that figure could hit $13 trillion. If the U.S. economic recovery falters, big investors might start dumping U.S. debt, which would likely result in a further weakening of the dollar vs. the world's other major currencies.
U.S. corporate earnings & corporate responsibility - The buck has had a difficult decade in part because of underperforming corporate earnings, not to mention underperforming corporate leadership. Institutional investors, particularly foreign ones, will not likely tolerate another cycle of fraud, mortgage bond losses, and corporate irresponsibility, and will likely sell dollar-based assets, if these trends once again rear their ugly head. That puts the onus on Congress to establish an effective regulatory framework to ensure that the scandal era is over.
Oil - Yes, it's true that the dollar affects the price of oil, but the price of oil also affects the value of the dollar. If demand for crude increases at an unusually high rate as the global economy starts to recover, U.S. inflation will increase and GDP growth will be constrained, each of which would hurt the dollar. It goes without saying, then, that it makes macroeconomic sense for the United States to increase energy efficiency and reduce the net negative impact that a rise in oil prices has on the U.S. economy.
Monetary Analysis: Of the above metrics, keep a close eye on U.S. GDP and oil. Stronger-than-expected U.S. GDP growth would suggest that the economy is coping with its restructuring, and that holds the promise of job growth. Further, it looks like the economy can cope with any oil price that doesn't remain over $110-120. Longer-term, 2011-2016, it's likely the U.S. economy will have prepared for even higher oil prices. If both trends run in the economy's favor, they'll support the buck. In sum, the dollar continues to hold its own, but the journey remains a long one to strong dollar territory.