US DOLLAR: HOW MUCH FURTHER CAN THE US DOLLAR FALL? With dollar denominated assets yielding next to nothing, we have continued to see money flow out of the US dollar. The greenback fell to the lowest level against the Euro since September and dropped to a new 13 year low against the Japanese Yen. The losses have been even more staggering since the beginning of the month. The dollar has fallen 14 percent against the Euro and 8 percent against the Japanese Yen. This significant sell off begs the question How Much Further Can the Dollar Fall? If you watched the price action in the currency market this past year, you will know that trends dominate. With only 2 weeks until the end of the year, we could be stepping into a longer phase of dollar weakness. 5 Factors that Could Drive the US Dollar Lower in 2009 There are 5 factors that could drive the dollar lower in the first quarter of 2009: 1. Weaker Economic Data 2. Disappointing Corporate Earnings 3. Quantitative Easing 4. Fiscal Stimulus 5. Investor Outflow With more Americans losing their jobs or having their salaries frozen, there is no question that the US recession will deepen in the first quarter of the New Year. Therefore not only do we expect fourth quarter GDP to be particularly weak, but we also expect a larger decline in retail sales and non-farm payrolls. In combination with the strength of the US dollar in the third and fourth quarters and the losses sustained in the Madoff Ponzi scheme, there is a strong chance that Q4 corporate earnings will be very weak for both financial and non-financial companies. Disappointing data could raise fears that the recession will turn into a depression, which could fuel further losses in the US dollar. In addition, quantitative easing and fiscal stimulus will pick up next year. Quantitative easing is akin to printing money, which dilutes the value of the dollar. More fiscal stimulus means more spending by the US government, which is also dollar bearish. These reasons along with the ultra low level of US rates are why investors could stay out of US dollars in the first quarter of 2009. Does it Matter if Other Central Banks are Cutting Interest Rates? One question that we have been asked multiple times today is whether it will matter if other central banks are still cutting interest rates at a time when the Fed has run out of room to reduce interest rates. The Euro currently has a 225bp interest rate premium over the US dollar. The ECB would have to cut interest rates by a lot in order to bring them anywhere close to US levels. Therefore, money will still flow into the higher yielding currencies, particularly the ones where the central bank is considering not cutting interest rates at their next monetary policy meeting (EUR and AUD). We do expect the trend of dollar weakness to eventually reverse as Quantitative Easing and Fiscal Stimulus finally helps the US economy, but that may not be until the second half of 2009 at the earliest. The only thing that could turn the dollar around would be if all of sudden the ECB cuts interest rates by another 75bp at their next meeting. K.Lien.