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The dollar had its biggest gain against the euro in five years as concern about Europe’s debt crisis spurred demand for alternative investments while the Federal Reserve embarked on a plan to buy U.S. debt.

The U.S. currency weakened against 12 of its 16 major counterparts as record-low interest rates sent investors searching for higher-yielding assets. The yen was the best performer against the greenback in 2010 even as the Japanese government took steps to weaken it. Currencies linked to commodities surged against the dollar as raw material prices hit records. U.S. employers added 140,000 jobs in December, a report may show next week.

“The euro-dollar relationship can be described as ‘who is worse off, Europe or the U.S.?’,” said Firas Askari, head currency trader in Toronto at Bank of Montreal. “To what extent is European contagion rampant? And to what extent have we seen the bottom of the bottom of the U.S. economy? At the end of the day, the U.S. economy is a real and strong economy.”

The Dollar Index, which IntercontinentalExchange Inc. uses to track the dollar, finished the year at 79.028, up 1.5 percent.

It rose in each of the first five months of the year as Europe’s escalating debt crisis boosted demand for U.S. assets. It declined from a high for the year in June before the Fed said it would increase asset purchases to boost growth and investors speculated the extra liquidity would debase the currency.

Fed Action

The dollar had a yearly gain along with global stocks, commodities and bonds, marking the first year since 2005 all posted annual increases. The Fed said Nov. 3 it planned to buy $600 billion of Treasuries through June to bolster the U.S. economy and address an unemployment rate at almost a 26-year high.

The 16-nation currency, which will add Estonia to its ranks today, was the worst-performing major currency against the dollar in 2010, sliding 6.5 percent, finishing the year at $1.3384. Economists surveyed by Bloomberg forecast the shared currency slipping to $1.31 by the end of 2011. The second-worst performer was the pound, which had 3.5 percent loss.

“Currency-market investors can only focus on one thing at a time,” said Mark McCormick, a New York-based currency strategist at Brown Brothers Harriman & Co. “We had the crisis in Greece, which had really protracted euro selling, then everyone shifted focus to the Fed with major dollar selling and in the last couple months the focus was back on Ireland and the euro-zone periphery and everyone became negative on the euro.”

Swiss Refuge

The Swiss franc also benefited from haven demand amid the European debt crisis, reaching records against the dollar, euro and pound. The franc gained 10.7 percent against the dollar and ended the year at 93.52 centimes.

The biggest winner against the greenback in 2010 was the yen, soaring 14.7 percent. The median estimate by 36 economists sees the Japanese currency reaching 90 in the fourth quarter of next year. It finished the year trading at 81.12 per dollar.

Japan’s Ministry of Finance confirmed the nation’s central bank purchased $25.1 billion and sold yen Sept. 15 to weaken the Japanese currency to curb gains that threatened an export-led recovery. The yen initially tumbled from almost a 15-year high against the dollar in the first Japanese intervention since 2004 before strengthening to 80.22 per dollar on Nov. 1, the high for the year.

Yen Factors

“One of the great ironies of 2010 was the fact that while the Japanese economy was one of the weaker performers in the G- 10 universe, its currency was one of the strongest,” Boris Schlossberg, director of research at online currency trader GFT Forex in New York, wrote to clients. “The appreciation in the yen wasn’t driven by Japanese fundamentals, but rather by risk- aversion flows in Europe and compression of yields with the U.S.”

Countries including Brazil to Taiwan took measures last year to devalue currencies and loosen monetary policy to safeguard export-led growth. Brazilian Finance Guido Mantega, fighting what he has described as a “currency war, raised taxes on foreign inflows twice to stem a rally in the currency, which gained 5 percent in 2010.

The Australian dollar was the second-best performer against the greenback, climbing 14 percent. It touched the strongest level against the U.S. currency since it became free-floating in 1983.

Raw Materials

Commodity prices, including gold and copper, reached records last year, bolstering the Canadian dollar to a 5.5 percent gain against the greenback and New Zealand’s dollar to a 7.9 percent advance. The Thomson Reuters/Jefferies CRB index of 19 raw materials gained 17.5 percent.

Asian currencies recorded their best annual performance since 1998, as the region’s fastest pace of economic growth in the world and widening interest-rate premiums attracted capital from overseas. The Bloomberg-JPMorgan Asia Dollar Index, which tracks the 10 most-active currencies excluding the yen, climbed 5.3 percent in 2010.

China’s yuan strengthened beyond 6.6 per dollar on Dec. 31 for the first time in 17 years. The Chinese government ended a two-year peg to the dollar in June that had limited the currency’s appreciation.

The dollar’s share of global foreign-exchange reserves fell to the lowest in at least 11 years in the third quarter as central banks increased holdings of non-traditional currencies, International Monetary Fund data showed Dec. 30.

The share of “other currencies,” which excludes reserve holdings of U.S. dollars, euros, British pounds, Japanese yen and Swiss francs, rose to 4 percent from 3.7 percent in the previous quarter, the most in at least 11 years.

U.S. employers added jobs in December and the unemployment rate declined to 9.7 percent from 9.8 percent November, the first drop in six months, according to a median forecasts of a survey of 55 economists by Bloomberg News. The Labor Department report is scheduled for Jan. 7. Bloomberg

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