There's at least one thing that bulls and bears on the U.S.economy agree on: the dollar, the most undervalued major currencyin the world, is due to rise as Europe's sovereign debt crisisthreatens the global recovery.

Strategists who as recently as November were predicting thedollar would depreciate against currencies of the Group of 10nations, now say it will climb by year-end. After weakening againstall but the Mexican peso among its 16 most actively traded peersover the past decade, it has gained against 13 of them sinceFebruary.

Bulls say the dollar will benefit from increased U.S. hiring andan economy that's projected to grow 2.3 percent this year, almostdouble the 1.26 percent for the Group of 10, according to Bloombergsurveys of economists. The currency will also gain if global andU.S. growth slows as Europe's debt crisis worsens, boosting demandfor dollar assets such as Treasuries as traditional havens frommarket turmoil diminish.

“We've become more bullish on the dollar because the economicprospects in the U.S. are improving,” Ken Dickson, an investmentdirector of currencies at Standard Life Investments in Edinburgh,which manages about $235 billion, said on April 18 by telephone.“There are additional reasons including problems in the periphery,and a weaker euro is required to help the transition to a bettereconomic situation in Europe.”

Scotland's second-biggest money manager is “overweight” thedollar against the yen and the euro, meaning it owns a greaterpercentage denominated in the currency than is contained inbenchmark indexes. The greenback may climb about 9 percent to $1.20per euro in the next six months, Dickson said.

Currency analysts predict it will appreciate 1 percent versusother G-10 currencies by the end of this year, according to theaverage median estimates of strategists surveyed by Bloomberg, froma 4 percent drop expected in November.

It strengthened 0.7 percent to 81.52 yen last week and fell 1.1percent to $1.3219 per euro. The dollar slid 0.6 percent to 81.06yen as of 9:59 a.m. London time, and appreciated 0.5 percent to$1.3147 per euro.

Currency strategists expect the dollar to advance to $1.30 pereuro and 84 yen by year-end, based on the median estimate of atleast 46 analysts compiled by Bloomberg. That compares withNovember estimates of $1.41 per euro and 80 yen.

Japan, Switzerland

Demand is being buoyed as central banks in Japan and Switzerlandresist gains in their currencies, with both nations seeking toprotect their exporters from rising prices for their goods. Thatleaves the dollar as the sole haven for investors seeking refugefrom Europe's crisis.

Japan has intervened to curb the yen's 60 percent appreciationover the past decade. The currency surged to a post-World War IIrecord of 75.35 per dollar in October before slipping about 8percent. The Swiss National Bank imposed a 1.20 franc per euroceiling on Sept. 6, and the franc has fallen 0.3 percent versus thedollar since the end of that month.

Global gross domestic product will expand 3.5 percent this yearand 4.1 percent in 2013, the International Monetary Fund said lastweek in its World Economic Outlook, raising forecasts made inJanuary from 3.3 percent for 2012 and 4 percent for next year. TheU.S. will grow 2.1 percent this year and the euro area is projectedto decline by 0.3 percent in 2012.

The euro zone's $12.1 trillion economy is the world'ssecond-largest, after the U.S.'s $14.6 trillion, according to datacompiled by Bloomberg.

There's a risk of the euro sliding to $1.25 “if sovereignfunding conditions deteriorate significantly,” John Normand, theLondon-based head of currency strategy at JPMorgan Chase & Co.,said April 19. “Our view is that the funding stress, althoughintense sometimes, is manageable” and the euro may rebound to $1.34this quarter, he said in an interview.

While the dollar has benefited from its role as the world'sreserve currency, with 62 percent of global holdings, its valuefell in foreign-exchange markets as the Federal Reserve printed$2.3 trillion to inject into the economy after the financial crisisbegan five years ago.

IntercontinentalExchange Inc.'s Dollar Index, which tracks thecurrency against those of six trading partners, tumbled 14 percentduring the Fed's two rounds of asset purchases, known asquantitative easing, or QE, between December 2008 and June2011.

Strategists who expect the dollar to decline say that while theU.S. unemployment rate is at the lowest in three years, payrollsincreased by the least in five months in March and the Fed mayintroduce more QE before year-end.

Bernanke's Assessment

More Americans than forecast filed applications for unemploymentbenefits in the week through April 14, a government report showedon April 19, adding to signs the improvement in labor-marketconditions may be faltering.

Fed Chairman Ben S. Bernanke said last month that further“significant” improvements in employment would probably require amore-rapid expansion.

“Prospects of QE3 had never left the table,” said MichaelWoolfolk, senior currency strategist in New York at Bank of NewYork Mellon Corp., the world's largest custodial bank, with morethan $26 trillion in assets under custody and administration.

Woolfolk expects the dollar to weaken to $1.40 per euro and toappreciate to 90 yen by the end of the year.

“QE3 would send a signal that the Fed wants to continue to growthe balance sheet and continue with the foot on the accelerator interms of monetary policy,” he said. “This would be viewed asnegative for the dollar by the market.”

The odds of more easing measures by the Fed are 50 percent orhigher, the majority in a Bloomberg News survey of the 21 primarydealers that trade with the Fed showed this month.

Longer-term depreciation has left the dollar as the only G-10currency undervalued versus the euro, by 5.6 percent, based on anindex by the Organization for Economic Cooperation and Developmentthat uses relative costs of goods and services.

The dollar is too weak by 31 percent against the yen and 24percent compared with its Canadian counterpart, according to theParis-based OECD.

“The dollar is probably about 20 percent undervalued,” JohnTaylor, who manages about $4.5 billion as founder and chiefexecutive officer of New York-based currency hedge fund FX ConceptsLLC, said in an April 20 telephone interview. “It will be strongeragainst the euro and yen and even against the emergingmarkets.”

Central Bank Steps

Like the Fed, policy makers in Japan and Europe have taken stepsto support their economies with fiscal stimulus.

The Bank of Japan is “committed” to monetary easing, GovernorMasaaki Shirakawa said April 18 in a speech in New York. TheEuropean Central Bank issued about 1 trillion euros ($1.3 trillion)in three-year loans to area banks in two longer-term refinancingoperations, or LTROs, in December and February.

New Fed stimulus may be sterilized, which would involve thesimultaneous draining of cash from the banking system through therepurchase agreement market. The central bank is now replacing $400billion in shorter-term holdings with longer-term debt in a programcalled Operation Twist that expires in June.

“The bias at this point is toward steady monetary policy in theU.S. relative to other central banks that could ease further,” NickBennenbroek, head of currency strategy at Wells Fargo & Co. inNew York, said in an April 17 telephone interview. “The economy inthe U.S. is going to be steady, so when we look at those trendselsewhere, we feel the dollar should benefit overall.”

Wells Fargo revised its year-end forecast for the dollar againstthe yen to 84 last week, after predicting 80 yen at the beginningof the year. It expects the greenback to end the year at $1.24 pereuro.

The Dollar Index has rallied more than 2 percent since the Fedannounced the start of Operation Twist on Sept. 21. Indicators suchas retail sales, manufacturing and consumer confidence signal apickup in the recovery.

Consumer sentiment has been above 70 every month this year,according to the Thomson Reuters/University of Michigan index. Thegauge averaged 64.2 during the last recession and 89 in the fiveyears before the crisis. Retail sales rose 0.8 percent in March,exceeding the 0.3 percent median estimate of 81 economists surveyedby Bloomberg, Commerce Department data last week showed.

The ISM index of manufacturing activity jumped to 53.4 lastmonth, from a two-year low of 51.4 reached in July. It is down froma high of 59.9 in January 2011.

Futures Bets

Bets on dollar gains are growing as Europe's debt crisis, whichstarted in Greece in October 2009, persists. Italy last weekdelayed its goal to balance the budget by one year to 2014, joiningSpain in missing fiscal targets amid a worsening recession.

Hedge funds and other large speculators increased bets thedollar will rise against the euro to 118,125 contracts in the weekended April 17 from 101,364 the previous week, according toCommodity Futures Trading Commission data. Against the yen, futurestraders are long the dollar by 57,803 contracts.

“We expect the U.S. economy to outperform a lot of Europe,therefore we look for the dollar to appreciate over the course ofthis year,” Sara Yates, a foreign-exchange strategist at BarclaysPlc in London, who sees the dollar climbing to $1.25 in six monthsand $1.20 in a year, said in an interview on April 17. “It's alsothe case that if we get euro-area risk really coming back to thefore, then the dollar will do well.”

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