The dollar has been on a bit of a rally lately, making up lost ground against currencies like the Japanese yen, and is frequently at the center of the news when Federal Reserve policy is being discussed. Monetary policy in general continues to be a concern for the world’s leading economies, as countries are worried about an overly strong currency in the face of tepid growth. A weak currency means greater exporting opportunities, in turn leading to a greater possibility of growth for that economy. Some companies worry that a stronger dollar will depress earnings because their international profits will be worth less when converted back into dollars. Whatever the ramifications, there are reasons for the dollar’s growth, and here’s a look at five of them:
1. The End of Easing
Most fundamentally, markets are scared that the Federal Reserve’s quantitative easing program could be on the way out sometime next year, with “tapering,” or a slowdown in asset purchases, happening as soon as this fall should the economic conditions warrant it.
The talk of tapering alone sends the markets into a tizzy, causing interest rates on U.S. bond yields to spike and making the hiked-up rates more lucrative to investors from all parts of the globe, thus pushing up the dollar.
2. Substantial Economic Growth
The U.S. is slowly moving back toward substantial economic growth, albeit at a miserably slow rate for much of the country. The economy grew 1.8 percent in the first quarter, and the International Monetary Fund has been predicting stronger growth going into next year.
The fight is an uphill battle, and the increasing tax burden has been cited as a possible reason for second-quarter slowdown this year. Still, the U.S. added jobs in the first quarter, averaging 200,000 per month this year, and the housing market continues to do nicely, variables that could be prompting a fall exit from quantitative easing that markets are worried about. All this combined makes for a stronger dollar.
3. Mario Draghi’s Moves
The president of the European Central Bank, Mario Draghi, is a man able to change markets without spending a cent. His Outright Monetary Transactions program worked to soothe markets of higher interest rates in Europe by offering the promise that the bank could by bonds to drive down rates. This never happened, but rates went down anyway.
Now he has broken from ECB tradition and offered “forward guidance” to markets, telling them to expect low rates for an extended period of time. With low rates and easy money a continued trend in Europe, and with the Fed looking to get out of the easing game, the dollar is a clear winner in this situation.
4. Emerging Market Slowdown
Investors once turned to emerging markets like Brazil, China, and others as havens for high returns in a crisis-ridden U.S. economy and a floundering euro zone. Now the tables have turned on these investors: with China’s slowdown and Brazil’s questionable government, the lucrative returns that once existed are looking more dubious.
With a rebounding U.S., some are now thinking that this is the place to be for solid returns, especially with a dominant performance by equities over the course of the last year. When investors start leaving emerging economies for the U.S., the dollar is the beneficiary.
5. New Federal Reserve Chair
This has perhaps not fully gripped markets yet, but momentum is surely in President Barack Obama’s favor when he picks the new Federal Reserve chair. A number of reports say Former Treasury Secretary Larry Summers has the President’s ear, but whether this means he will edge out Fed Vice Chair Janet Yellen remains to be seen.
Markets are much more friendly toward Yellen, who is expected to be more lenient with quantitative easing, while Summers is widely seen as more hawkish toward the asset-purchasing program. David Forrester, a G10 foreign exchange and fixed income strategist at Macquarie Bank, told CNBC that Summers’s appointment as chairman of the Fed could result in a stronger dollar, saying, “Summers questions the efficacy of QE.”