The dollar's best monthly performance since November may provefleeting as a slowing U.S. economy and falling short-term interestrates encourage investors to use the currency to fund investmentsin higher-yielding assets.

The U.S. currency's value will be unchanged from current levelsby year-end, down from last month's predicted 2 percentappreciation, according to analyst forecasts compiled by Bloomberg.Bets remain tilted against the greenback even after last month's2.3 percent gain in IntercontinentalExchange Inc.'s Dollar Index,Commodity Futures Trading Commission data show.

While the dollar gained against 14 of the 16 most-tradedcurrencies in May, it fell last week after weaker-than-forecastreports on manufacturing, employment and consumer confidence ledtraders to raise bets that the Federal Reserve will keep rates nearzero. Traders also found less reason to seek shelter in thecurrency as European officials agreed to provide more financial aidto Greece and German Chancellor Angela Merkel said the EuropeanUnion is committed to keeping the euro intact.

“The dollar's rebound is not a turning point in the bear trend,”said John Normand, head of currency strategy in London at JPMorganChase & Co., the world's fifth-biggest currency traderaccording to Euromoney Institutional Investor Plc. “A sustaineddollar rally requires a Greek default, a global recession oraggressive Fed tightening. And those are not likely to happen thisyear.”

Gains Reversed
Last month's 1.5 percentrise against nine exchange rates tracked by the BloombergCorrelation-Weighted Indexes was the dollar's first gain sincerallying 4.1 percent in November. Only the Swiss franc and NewZealand dollar appreciated more.

The dollar weakened 0.9 percent last week as measured by thegauge. It fell 1 percent against the euro to $1.4635. The singleEuropean currency strengthened against all the most-tradedcounterparts apart from the South African rand and the Danishkrone.

Falling short-term rates in the U.S. means that borrowing indollars to buy currencies of economies with higher yields hasbecome profitable in the last two weeks, returning 0.4 percent,after losing 2.4 percent from April 29 through May 23, according toan index compiled by UBS AG.

Traders who borrowed in U.S. dollars to buy Australian assetshave earned 2.2 percent after losing 3.3 percent in the first threeweeks of May, according to data compiled by Bloomberg.

The Fed has kept its target rate for overnight loans betweenbanks in a range of zero to 0.25 percent since December, 2008. TheEuropean Central Bank raised borrowing costs in April for the firsttime in almost three years, bringing the main refinancing rate to1.25 percent.

Relative Yields
China, Russia, Norway, Sweden,Poland, South Korea, Thailand, India, Indonesia, the Philippines,Malaysia, Taiwan, Chile and Brazil have raised borrowing costs thisyear.

Treasuries due in one to three years yield 1.01 percentagepoints less on average than government debt with similar maturitiesin the rest of the world, Bank of America Merrill Lynch indexesshow. That compares with 0.59 percent less at the beginning of theyear.

A weaker dollar hasn't hurt the ability of the U.S. to attractthe foreign capital needed to fund a budget deficit in excess of $1trillion. The Treasury has received $3 in bids for every dollarauctioned this year, compared with last year's record $2.99,Treasury data show.

U.S. exports reached $172.7 billion in March, up 4.7 percentfrom the prior month and the biggest gain since 1994, according toa government report.

End of QE2
Dollar weakness is unlikely tobe uniform. It may appreciate to $1.40 versus the euro by the endof the year, according to the median estimate of 51 forecasters ina Bloomberg News survey. It's projected to gain 8.2 percent againstthe yen, 0.9 percent versus the Norwegian krone and 3.7 percent tothe Australian dollar, separate surveys show.

The dollar may also get support as the Fed stops printing moneyto buy $600 billion of Treasuries in a second round of so- calledquantitative easing, or QE2. The end of the program this monthreduces the availability of the currency in the market.

“If the U.S. stops debasing the currency or easing, then it'stime for investors to stop selling dollars,” said Geoffrey Yu, acurrency strategist in London at UBS AG, the third-largestforeign-exchange dealer. “The risk to this view is that the marketis concerned the Fed could be prompted to increase asset purchasesto keep growth expectations intact.”

Yu said he expects the dollar to gain to $1.35 against the euroin the next three months.

Risk Reversals
Traders aren't asoptimistic. Demand for contracts protecting against a drop in theeuro versus the dollar is down from the highest since December.

The so-called risk reversal rate for one-month put optionsgranting the right to sell the euro fell to a 1.64 percentage-point premium over calls giving the right to buy, down from 1.94percentage points May 26.

“The general trend of dollar weakening will continue until theFed signals that it's going to raise rates,” Greg Anderson, asenior currency strategist at Citigroup Inc. in New York, said.

The outlook for higher U.S. rates this year faded last week asreports showed manufacturing for May expanded at the slowest pacein 20 months, the unemployment rose to 9.1 percent in May andconsumer confidence fell to a six-month low.

Futures on the Chicago Board of Trade show traders see a 10.9percent chance the Fed will increase its target rate in 2011, downfrom 22 percent a month ago.

Trimming Forecasts
Economists at BarclaysCapital Inc. cut their forecast for second-quarter economicexpansion on June 3 to a 2 percent annual rate from a priorestimate of 3.5 percent. They lowered their projection for thethird quarter to 3 percent from 3.5 percent. The U.S.'s 1.8 percentgrowth rate last quarter compares with 2.5 percent in the eurozone, 3.92 percent in Canada and 6.4 percent in Sweden.

Net bets the dollar will drop against the euro, yen, pound,Australian dollar, Canadian dollar and Swiss franc increased to126,029 as of May 31, from 101,398, the week before, the leastsince January, Commodity Futures Trading Commission data show.

The Dollar Index, which tracks the greenback against the euro,yen, pound, Swiss franc, Canada dollar and Swedish krona, fell toan almost one-month low of last week of 73.698 from 76.366 on May23. The gauge is weighted 57.6 percent to movements in the euro,which has the support of European lawmakers and centralbankers.

Investors are betting the European Union and InternationalMonetary Fund will delay a sovereign default in Greek debt untilafter the European Stability Mechanism comes into effect in 2013.EU and IMF officials agreed last week to pay the next installmentto Greece under last year's 110 billion-euro ($161 billion)bailout, paving the way for an upgraded aid package.

No 'Euro Problem'
“We don't have a europroblem in Europe,” Merkel said in a speech in Singapore June 2.“We have more of a debt problem.”

Germany is committed to the euro, which is stable, she said. Theoutlook for growth in the country's economy, Europe's largest, is“very positive,” Merkel said.

“Europe might not be perfect, but leaders are committed to theproblem and I think they will find a solution,” said PierreLequeux, London-based head of currency management at AvivaInvestors, which oversees about $370 billion. The “U.S. is in anenvironment where the problem is ahead of it and not behind it,” hesaid.

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