Macroscope | What’s behind the dollar surge? Look to Europe, not US interest rates

Since April 16, the dollar index, a gauge of the greenback’s performance against a basket of other leading currencies, has shot up more than 4 per cent to its highest level since the end of 2017. Last month, the dollar enjoyed its best month since Donald Trump’s victory in the US presidential election in November 2016. 

As I argued in an earlier column, a rebound in the dollar was overdue, given the growing divergence in global monetary policies. While the Federal Reserve has become increasingly confident in raising interest rates further as inflation picks up, its European and Japanese counterparts are in no rush to end their quantitative easing (QE) programmes, given the persistence of subdued inflation. 

While this divergence failed to buoy the greenback last year – despite the Fed’s four interest rate hikes between March 2017 and March 2018, the dollar index fell 11.5 per cent – the correlation between government bond yields and exchange rates appears to be reasserting itself. The rise in the benchmark 10-year Treasury yield to the symbolically important 3 per cent level, coupled with the doubling of the yield on its policy-sensitive two-year equivalent since September 2017, have contributed to the recent rally in the dollar. 

Yet the main source of support for the strengthening greenback – and one of the most important drivers of markets right now – is the sudden deterioration in Europe’s economy.