A Resurgent Dollar Could Be 2010's First Surprise

This past year sure was packed with stunning turnarounds: Few foresaw a soaring stock market but tumbling approval ratings for President Obama. And it may have one last twist in store for investors.

Many investors saw a crumbling dollar as a sure bet in the wake of the Federal Reserve's unprecedented liquidity injections, but over the last month the greenback has instead mounted a sharp turnaround. And while the mainstream sentiment remains negative on the currency, a high-profile minority of investors – with both more bullish and bearish economic outlooks than most -- are now betting that the rally will continue into the new year.

The convergence of views about the dollar from investors in both contrarian camps and who correctly anticipated the stock market rally may be revealing about the year ahead. While the status quo predicts a gradual downward move for the greenback amid a limp economic recovery, any surprises -- whether positive or negative -- could lead to a sharp reversal. And if 2009 was any indication, investors should remember that things rarely play out in the smooth way that the consensus predicts.

The dollar has already gained about 5% against a basket of currencies during the last month. Butanother 10% move upwards for the greenback could be in store, according to Barton Biggs, the managing partner of powerhouse hedge fund Traxis Partners. Biggs, who suspects an economic recovery could be much stronger than is widely believed, has been bullish on stocks and sees the S&P 500 gaining another 10% as well.

Bounce Now, Bomb Later

But even Marc Faber, who predicts the dollar will ultimately be worthless because of the Fed's money-printing, sees a strong if temporary bounce on the horizon for the greenback. Eventually, though, Faber sees the Fed's liquidity injections driving up inflation, and he expects investors to ditch assets like cash and Treasuries in favor of equities as a result.

Noted analyst Robert Precther of independent forecasting firm Elliott Wave International, sees the Fed running out of ammo in the face of a collapsing economy in the year ahead. The resulting deflationary environment will send investors racing to the safety of the dollar, Precther argues.

However, some bullish investors say the start of the year could bring a stronger rebound in jobs than most predicted. One in that camp is Charles Schwab Chief Investment Officer Liz Ann Sonders, who recently wrote that panicked companies went overboard in cutting jobs amid the downturn. Judging by the GDP declines and correlating job losses during prior recessions, she noted, employers may have fired 30% more workers than they should have.

Now that business confidence is recovering, "many companies concede they didn't just cut employment to the bone, but into the bone," Sonders wrote. Surprisingly strong recent jobs reports and blistering temp hiring may be testament to the sharp rebound that lies ahead. And the resulting Fed tightening of liquidity in response could further shore up the dollar.

Bad News for Commodities?

The impact of a rising dollar on other assets remains unclear. While a rise in the dollar usually led to a fall in stocks for much of the year, that correlation has abated recently. Commodities like oil and gold -- the latter was especially seen as a play on a crumbling dollar -- could get hit hard by a resurgent greenback.

But whether the year ahead brings a brisk recovery or more chaos, a sharp rally in the greenback -- left for dead not long ago -- could be in store.