Why Has The U.S. Dollar Been So Strong?

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Includes: DEUR, DJPY, DRR, ERO, EUFX, EUO, FXE, FXY, JYN, UDN, UEUR, UJPY, ULE, URR, USDU, UUP, YCL, YCS
by: Discount Fountain
Summary

The dollar has had a strong run in 2018.

However, the dollar is still significantly below highs seen in 2015 against the euro and yen.

We could well see further strength in the greenback going forward.

The dollar has been a top performer this year against all major currencies.

For instance, over this year we can see that the greenback is up by nearly 10% against the Aussie dollar, while the only currency that has continued to show some strength against the dollar is the yen, with the USD/JPY rising 0.63%:

Source: investing.com

The currency market has been rather peculiar this year. On the one hand, equity markets have been treading with caution over fears that trade tensions might escalate. However, the dollar has continued to remain strong along with the yen, the latter traditionally being a safe haven currency. While one might have expected that the dollar was overvalued and would lose its strength in the latter half of this year, this has clearly not happened.

So, what is causing such strength in the greenback and can we expect it to continue?

Well, the major reason is interest rate hikes (surprise, surprise). Back in 2016, we saw currencies such as the New Zealand dollar gain against the greenback, as interest rates continued to remain higher than in the United States. However, that relationship has now been turned on its head, and with higher rates being offered on the dollar than previously, it is little wonder that this currency has been so strong.

So, there are two important questions:

  1. Can we expect further upside from the dollar going forward?
  2. How long can we expect this to last?

On the first question, let’s compare the USD/EUR and USD/JPY over a longer time period.

USD/EUR

Source: investing.com

USD/JPY

Source: investing.com

For these two currency pairs, we can see that while the dollar has gained strength recently, levels are still well below the highs seen for the dollar in 2015. With the ECB not set to raise interest rates until mid-2019 at the earliest and Japan continuing to follow a policy of quantitative easing, the dollar has room to rise further.

Therefore, in terms of how long we can expect this rally in the dollar to last, we could theoretically get to a point where the dollar is trading at the 0.95 level against the euro - the yen is showing resiliency in this environment as a safe haven currency, so gains against the yen could be more limited.

From an economic standpoint, even with trade tensions in place, America’s economy continues to be comparatively strong.

For instance, while both economies appear to have stabilizing inflation at a target of 2 percent, GDP growth and the unemployment rate is both higher and lower respectively in the United States when compared to the Euro area:

GDP Growth

Source: investing.com

Inflation

Source: investing.com

Unemployment

Source: investing.com

Taking this into account, I expect that we will continue to see strength in the dollar, and given the growth disparity between the United States and Europe, I particularly expect that we are going to see a strengthening of the dollar against the euro going forward.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.