News regarding the foreign exchange market is usually found on the back pages of most major newspapers. Over the last few weeks, however, the incredibly strong U.S. dollar is front page news and the lead story on many business television networks. Some of the numbers are pretty amazing – the U.S. dollar is at a five-year high against the Canadian dollar, a seven-year high against the Japanese yen, a 12-year high against the euro, and at an all-time high against the Mexican peso.
Part of the reason the dollar is dominating news, is the unprecedented speed at which it is rising. Going back to the beginning of floating exchange rates in the early 1970s, there has been only one other period of time (early 1981) where the dollar has advanced this quickly. What makes this even especially interesting is that while the dollar’s recent advance has been sharp, the duration of the recent climb is relatively short compared to other multi-year advances of the dollar during the 1980s and 1990s.
The reasons for the dollar’s gains are well known but are worth repeating because this trend could be in place for many more months. The main reason is the divergence in monetary policy between the U.S. and many of its G7 and G20 trading partners. Twenty-three central banks have cut interest rates since the beginning of the year, while the market is pricing in the U.S. Federal Reserve raising interest rates sometime near June. Particular attention is focused on the euro as the European Central Bank has just embarked on its quantitative easing program where eurozone interest rates continue to move lower.
How long can this trend run? History has shown us that when the U.S. dollar reached extreme highs or lows, it took concerted government intervention to help turn the tide. So far, the U.S. government and U.S. Treasury Department have yet to complain about the strong advance of the dollar as the economy here continues to produce steady growth. A weaker euro helps to stimulate exports for the eurozone and to strengthen their weak economies.
Our View: We are at the beginning of this dollar trend rather than at the end. We will be seeing more multi-year and all-time highs against the dollar’s counterparts as this trend continues.
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