The US Dollar has been steadily falling from June 2010 thru September 2011 and even as fears were mounting about it breaching key support levels it bounced off and was rising for over 5 weeks since then. This week it is consolidating even as equities are bouncing higher.

The fear of further weakness in the Dollar is very real with all the uncertainty that's playing out in the financial system worldwide. In these circumstances it will be difficult to project the course of the Dollar in the coming years but we can safely say that the following major factors will have a big role to play in the eventual outcome.

Strength of EU Zone and Euro

The Euro until recently was touted as a solid currency challenging the Dollar's hegemony. But recent developments in the EU has literally shaken the financial foundation of the region and for at least the next 3 to 5 years consolidation of the EU Zone financial system will be a major task that will keep the EU Zone busy. Until things stabilize in the EU, the Euro cannot be expected to strengthen much further. This will work to the advantage of the Dollar.

State of the US Economy

The biggest risk element for the Dollar is the US Economy. In the long run, the stronger the US Economy the stronger will be the Dollar. An intentional weakening of the Dollar will continue to happen for various economic reasons but if the US economy continues to struggle and enter a clear recession, the US Dollar has the potential to be impacted much more severely than it is now. In our view this is the biggest headwind that the currency faces in the next 2 to 3 years.

Corporate Profit Repatriation

Somewhat offsetting the negative influence of a weak US economy will be the effect of corporate repatriation of overseas profits. A favorable tax relief for corporations can trigger a massive inflow of Dollars which has the potential to give a boost to the currency in the near term. This is one factor that investors will need to keep an eye on in the short term.

Strength of the Chinese Economy

This is a wildcard to a great extent though the long term view is that the Yuan will become convertible. If this event happens faster and if the Chinese Economy overshadows the rest of the world in a big way, there is a strong likelihood that it will somewhat disturb the reserve currency status of the Dollar.

Despite the various headwinds, the Dollar as of today remains the most established safe haven currency and any unintentional weaking of the currency will not be very easy to justify in the very short term.

Since an intentional weakening is a possiblity, establishing long positions have to be technically co-ordinated as the fundamentals and technicals may not go hand-in-hand in the case of this reserve currency.