The dollar’s strength in 2005 came as a surprise to many in the foreign exchange market. Far from falling out of bed, as most analysts predicted, the dollar posted significant gains against most other major currencies. Over the past 12 months, it has risen by more than 11% versus the euro, 7% against the pound, and by an even more impressive 15% versus the yen.
As Lehman Brothers wrote recently in the bank’s outlook for 2006: “2005 was not particularly good for forecasters or macro traders. And nowhere did forecasters get it more wrong than in currency markets. Remember, 2005 was supposed to be a year of further US dollar weakness.”
Lehman adds: “The year 2005 had its share of big events – referendum defeats in France and Holland leading to talk of a breakdown in the euro; the long-awaited revaluation in China; and huge political shifts in Germany and Japan. In the end, none of these events had any lasting effect on currencies. Indeed, as we near the end of another eventful year, the only rule that really mattered was to buy the high-yielding currencies and sell the low-yielding ones.”
Trading in hindsight is always easy and the reasons why the dollar strengthened are now obvious.