<strong>JANE FOLEY<br />RESEARCH DIRECTOR, FOREX.COM<br /></strong>THERE has been a lot written in the last few days about the potential for a period of consolidation in the prices of many asset classes over the next three months. <br /><br />The earnings performance of many US companies in the third quarter didn&rsquo;t quite meet forecasts, while consumers remain under pressure from rising unemployment and the need to save more to replace their lost wealth. And 2010 will be a year when many governments will replace fiscal support with spending cuts and tax hikes. All of these factors suggest that economic growth will continue to remain below trend in the G7. <br /><br />Add in a withdrawal of quantitative easing, and we could see risk appetite at relatively low levels. A rise in risk aversion has already helped the US dollar, but it may be some time before we see a more convincing turnaround in the greenback.<br /><br />Monetary policy officials are now hinting at a possible pick-up in economy activity, which would imply a reining in of loose policy at some point. For example, the Bank of England last week only increased the amount of QE by a fairly conservative &pound;25bn, also signalling perhaps that it is losing faith in the policy. Supporters of QE continue to stress that the lack of inflation pressures suggests there is room for these plans to be extended. <br /><br />But the lack of response in either money supply or inflation indices could equally be illustrating that these plans are not having a significant impact on the real economy and are therefore no longer appropriate. <br /><br />If this is the Bank&rsquo;s view, then we could see QE phased out by February. In the US the Fed has already completed its $300bn of Treasury bond purchases and the Bank of Japan will stop buying corporate bonds at the end of this year.<br /><br /><strong>SURPRISING PROFITS<br /></strong>Equally supportive of the view that QE will be coming to an end early next year is the return to health of the banking sector. Aided by easy access to cheap money from the central banks, many banks have managed to recapitalise themselves since the height of the financial crisis and some investment banks have returned surprising profits after an extraordinarily short time. <br /><br />In the Eurozone, European Central Bank (ECB) President Jean-Claude Trichet indicated last week that there is a strong chance that the ECB will end its flagship policy of unlimited 12-month loan auctions in December. <br /><br />QE and the ready availability of cheap money undoubtedly helped drive the rally in risk assets since the spring. Whether or not it has sowed the seed of a speculative bubble in some asset classes is more difficult to ascertain. Either way, the reining in of QE and other extraordinary monetary policy measures is likely to have a dampening impact on risk appetite over the coming months.&nbsp; <br /><br /><strong>CONVINCING RECOVERY<br /></strong>In the near-term, the outlook for the greenback will continue to be driven by short-term rises and falls in risk appetite. A more convincing recovery is likely in the medium-term but this will be dependent on the markets becoming more aggressive about likely Fed rate rises, which could still be about five to six months away. In recent weeks US retail sales, industrial production, third quarter GDP and ISM manufacturing figures have all beaten market estimates, signalling a possible upturn in economic activity and therefore improving investors&rsquo; appetite for risk. <br /><br />While the economic outlook in the US, as in the UK and elsewhere, will be vulnerable during 2010 to the reversal of fiscal policies, the market is expecting real US growth to recover to an annual rate of around 2.4 per cent next year. This will probably translate into a hike in US rates during the second half of next year. <br /><br />Unemployment rates are likely to trend higher for a few months yet, but the relative flexibility of the US labour market suggests that payrolls could be fairly quick to recover once growth is firmly established. The strength of last week&rsquo;s US productivity data is significant &ndash; output per head in the third quarter rose to its highest level since the third quarter of 2003, suggesting that job creation may not be too far down the line, and this will help the employment figures. <br /><br />The cost of borrowing is likely to rise in the US before the Eurozone, where deflationary risks will be extended by currency strength. Also, Fed rates &ndash; currently 75 basis points below those of the ECB &ndash; could rise faster once they do start to increase. <br /><br />All of which suggests the dollar is likely to enjoy a more sustainable recovery than the sceptics are arguing &ndash; though not starting straight away.<br />ResearchEMEA@forex.com