The dollar will decline, so bet on the yen

So far in 2006, the developing "big story" has got to be the "pronounced decline" of the dollar, says The King Report. The currency had an unexpectedly good year in 2005, but its rally peaked on 16 November and has been looking wobbly ever since: so far in 2006, it has fallen slightly against the euro and the pound.

And that's a trend that may just keep going. Certainly, the odds are stacked against the dollar, says Morgan Stanley's Stephen Roach. Last year, the greenback gained as US interest rates rose, making the currency look relatively more attractive, given the low interest rates of Europe and Japan. But now, "with the Federal Reserve signalling that the end of its tightening cycle is now open to debate, I expect the interest-rate differential theme to fade in importance as a driver of currencies".

Instead, says Roach, investors are likely to remember an old theme America's "record current-account deficit". And that kind of refocusing won't be good news for the dollar.

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But if the dollar is currently no currency to be betting on, what is? The answer, says Roach, is the yen. "If the Japan story [of economic recovery] is for real and I suspect it is there are fundamental reasons for the yen to appreciate", given Japan has the world's largest current-account surplus.

Jonathan Allum of KBC agrees. Usually when Japan's economy is strong, so is the yen. In 2005 the hedging behaviour of "aggressive funds" meant this wasn't the case, but that doesn't mean the fundamentals won't reassert themselves this year. "Roll on 115 or 110 or 105 or 100 (to the dollar)."

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