Big bounce for the dollar is on the cards

Is the dollar set for a rebound? There are new warnings of a sudden rise in the greenback's value as investors appear to be growing wary of US exposure to surging foreign equity and property markets.

Signs that the dollar could be in for an surprise turnaround after its worst performance in seven years come from the $3.2-trillion-a-day foreign exchange market where the cost of insuring against a rebound has spiked. Investors, it appears, are concerned that new Dubai-style shocks are already in the pipeline.

The long period of low interest rates in the US has encouraged increased investment in foreign markets that may now be bubbles waiting to burst - and that would cause investors to flee back to the safety of US treasuries and push the dollar higher.

So-called "carry trades" of borrowing in one country with low interest rates to invest in others with higher rates (like Australia and New Zealand) have proved especially profitable and produced returns of 50 per cent over the past nine months.

But if the Fed raises rates, or the dollar abruptly strengthens when an unexpected bubble bursts, traders get caught on the wrong side.

Bill Gross, manager of the world's biggest bond fund, Pimco, says there may now be "systemic risk" of an event, similar to the collapse of Lehman Brothers, that would cause investors to seek a haven in the dollar.

Investors say the markets are anticipating a "BOB" or bolt-out-of-the blue event. "The world had a mini-BOB," said John Alkire, the chief investment officer at Morgan Stanley, when Dubai shook confidence with its surprise failure to make development debt repayments.

Mansoor Mohi-uddin, chief currency strategist at UBS, told Bloomberg News: "If investors become risk-averse again, which happened last year due to Lehman's bankruptcy and could happen now for a whole host of reasons, they are likely to go into less risky assets like US treasuries, which would help the dollar."

Despite unexpectedly good US employment data last week, investors are wary of the global economy falling back into recession. Identified potential troublespots include US commercial mortgages, global equity markets, and a new round of bank losses - as much as $1.5 trillion - that are yet to be reported.

Nouriel 'Dr Doom' Roubini, the New York University professor and playboy who predicted the financial crisis, said last week that Dubai's attempt to reschedule debt underscores the global economy's continuing vulnerability. "Although Dubai World's financing issues are not a surprise and are relatively small given global credit losses, they are a reminder that the vulnerabilities and imbalances that contributed to the credit crunch have not disappeared." ·