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What's Behind Comeback in the Dollar and Where It May Go Next

The decline in the dollar this year has left many observers writing off its future, but the big bounce in the last few weeks has garnered barely a mention. The currency has risen about 6 percent against the euro, leaving it at its lowest level since early September and - would you believe it? - down only about 2 percent since the start of the year.

Some, including a recent commenter here, have attributed the comeback in part to the alarming deterioration of public finances in Greece, which prompted agencies like Fitch and Standard & Poor's to cut their ratings on Greek government debt. That may have played a very minor role, but Greece has had trouble managing its finances since Homer wore short pants, so it can hardly explain the entire move in the dollar.

David Kelly, chief market strategist at J.P. Morgan Funds, offers a more plausible explanation. Europe as a whole suffered less during the recession, he told MoneyWatch, and so it is likely to show a more muted recovery. The bounce in the dollar reflects a desire among investors to capitalize on the swifter growth anticipated for the U.S. economy.

He expects the stronger U.S. growth, and the dollar's rebound, to be somewhat fleeting, but he wouldn't bet on the euro doing so well either. The best long-term economic performance is likely to be in the emerging economies of Asia and Latin America, in his view, and their currencies - and stocks and bonds denominated in them - are where the best investment prospects lie.

That makes sense - as long as you have faith that the global economy is on course for continued improvement. If you think there is less to the recovery than meets the eye, then you should expect investors to continue to bid up the dollar - not to capture stronger U.S. growth but to inoculate themselves against slower growth and greater risk everywhere.

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