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CHINA COULD PUT LID ON US DOLLAR RALLY

BORIS SCHLOSSBERG DIRECTOR OF CURRENCY RESEARCH, GFT US DATA continues to surprise to the upside, demonstrating that the country is well on its way to recovery and that it should join China as the second driver of global growth in 2010. Although last Friday’s US non-farm payrolls did not exceed the bullish forecasts of 200,000 new jobs, they nevertheless came in at a very respectable 162,000.

This signals a turn for the better in US labour conditions, especially given the upward revisions for prior months’ data. Overall, the US economy has added an average of 54,000 jobs per month in the first quarter of the year, indicating that the worst point of the recession may have passed.

There is still plenty of spare capacity left in the system – US economic growth is nowhere near its 2007 highs and unemployment is stubbornly high at 9.7 per cent and likely to stay at those levels for most of this year. Nevertheless, foreign exchange is a market of relative strength and with North America clearly outperforming the Eurozone and the UK, these fundamentals should translate into dollar strength for at least another quarter.

As I noted last week, I believe the dollar will continue to gain against the yen, while the euro – which is grossly oversold – may stage a small short covering rally. Yet any rally in the euro is likely to be temporary. Growth differentials between the US and the Eurozone will become more pronounced and the prospect of US rate hikes will become a distinct possibility in the second half of 2010.

Despite this sunny outlook for dollar bulls, the key risk is the growing tension in Sino-US relations. US officials have been pressuring China to revalue the yuan while Chinese authorities have fiercely resisted such a move. The US Treasury has wisely decided to postpone the release of a report that may have branded China a currency manipulator ahead of the visit by Chinese President Hu Jintao next week. However, if the two most important economies cannot work out their differences during the visit, the escalation in tension and possible recourse to protectionism could threaten the recovery and the dollar’s recent rally.

Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read daily commentary at www.GFTUK.com/commentary or e-mail them at BorisandKathy@gftuk.com.