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Confidence in the US economy will remain very weak in the short term. Following two successive declines in monthly employment, there are increased fears that the economy is already in recession. With the housing sector still deteriorating, there will be fears that there would be a prolonged downturn. The Federal Reserve has already cut interest rates sharply to hep support the economy with a drop in the Fed funds rate to 3.00% and there will be strong expectations of further interest rate cuts in the short term. The Fed will look to target alternative measures to support the economy, but yield support will remain weak. The dollar is still likely to secure some protection from fears over a downturn in the global economy and there will also be a further improvement in the underlying trade deficit which should provide some background dollar support.

The Euro-zone will weaken over the next few months and there is the possibility of a very sharp deterioration. Internal stresses within the Euro-zone are also likely to increase given that the economic performance is liable to diverge. The ECB will look to hold policy firm in the very short term, but there will be increasing pressure for rate cuts. There will also be increasing protests against Euro strength which will increase the possibility of intervention to curb Euro gains. Overall, the dollar will remain vulnerable in the near term, but should be close to a cyclical low point with a limited recovery realistic later in 2008.

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