In forex trading, there has to be a winner for every loser. John Crooks says the US dollar is set to be “king of the hill” in 2009. He says forex traders don’t care about the damage being done to the US economy. The greenback has become a “safe haven” for investors rushing into cash. And that trend isn’t about to change anytime soon.

This from Sovereign Society:

Yesterday, I told you all about the four currencies whose values promise to drop like rocks next year, thanks to the worldwide recession. And each of these presents substantial trading opportunities.

But the flipside to falling currencies is rising currencies. By definition when one currency goes down, it goes down in relationship to another. In this case, the U.S. dollar.

While most major currencies slumped, the dollar made the ultimate comeback in 2008 just in time for the U.S.’s greatest financial challenge since the 1930s.

Today, I’ll tell you why the almighty dollar effectively skipped the recession this year – even while the Fed slashed rates and spent not billions but TRILLIONS to fix a broken economy.

More importantly, I’ll also tell you what’s in store for the mighty dollar in 2009.

The Cinderella-Buck Arrived to the Ball Just in Time for a Recession -
But How Long Will She Stay?

The dollar is a testimony to how Mr. Market changes his mind. Just last spring, currency traders had effectively voted the dollar off the Forex island.

The dollar index hit an alltime low in mid-March, the day after the Fed bailed out Bear Stearns.

It’s a whole other story now. The greenback has become the Cinderella story of the foreign-exchange market in the last two quarters. Now, traders can’t buy dollars fast enough.

Overall, the dollar index has jumped 17% against the world’s majors just since August.

Cinderella Dollar Comes to Ball As Equities Sink

Dollar Index: Source: www.fxstreet.com

That’s just the major currencies. The dollar has also pulverized exotic currencies from Mexico to Turkey. In fact, exotic currency traders have made a killing (as much as 2,997%) this year, just by pairing the strong dollar against the weaker Polish zloty, Hungarian forint, Czech koruna and others.

Frankly, the soaring buck has many traders puzzled. And I admit – it does seem a bit counterintuitive for the dollar to rally now.

From a fundamental standpoint, traders generally watch interest rates and economic growth to gauge a currency’s “health.” And the U.S. dollar should be losing on both counts this year.

The Fed already slashed rates to 1%. Just yesterday, Fed chief Bernanke said additional rate cuts were “certainly feasible.”

As far as economic growth is concerned, Bloomberg reports that the U.S. government is prepared to spend US$7.7 TRILLION to pump liquidity back into the financial system. That’s roughly half the U.S.’s GDP for last year, so any meaningful surge in “economic growth” seems out of the question.

But Here’s the Thing: Forex Traders Don’t Care

Yes, that’s right: Forex traders couldn’t care less.

The dollar may be tangled with lower rates and slower growth, but as the world’s reserve currency, the dollar has taken on a new global status since the credit crunch began to squeeze stock markets. The dollar has become the world’s “safe haven” currency.

The more stocks sink, the more currency traders sell their positions for cash. In this case, “cash” is the U.S. dollar because Forex traders perceive the dollar as the safest bet in the global markets right now.

This sentiment has created a relationship between stocks and the dollar. As stocks (particularly U.S. stocks) fall, the dollar rises. And vice versa. In fact, just last week, the dollar index had its worst one-day decline since 1985. (Yes, I said “decline” – even an uptrending currency can have pullbacks.)

Why did the dollar index fall that day? Because stocks were temporarily rallying. The Dow had climbed almost 900 points in two days. For one day, the dollar lost its “safe haven” status, because investors started to inch back into stocks.

But it was a temporary pullback. This week, stocks are slumping again. Traders are selling their positions and running back into cash. Ergo, the dollar is rallying again. In other words, risk in the markets = profits for dollar holders in the Forex market right now.

If That Wasn’t Enough, the Buck Has More Perks…

Also, in the middle of a crisis Forex traders generally trade-in their high-yielding currencies to pay back what they’ve borrowed in cheaper, low-yielding currencies. This means the U.S. dollar’s recent disadvantage – now yielding 1% – has become an advantage in a risk-averse trading environment.

And if that wasn’t enough, it appears the Forex market traders believe the U.S. is better equipped to battle a global crisis. That’s because, unlike other more handcuffed, less resourceful nations, U.S. officials are willing to throw everything including the kitchen sink at credit problems (hence that US$7.7 TRILLION in bailout funds that Bloomberg reported).

Once again, this just gives Forex traders one more reason to vote “pro-dollar” this year.
So as long as risk remains in the market (which is a virtual certainty at this point), the dollar will continue to be the safe haven currency for at least the first half of 2009 – very likely longer.

Source: Why the Dollar Will Still Be King of the Hill in 2009