Is it really a case of US dollar strength?

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By David Absolon, Investment Director at Heartwood Investment Management

The Fed juggernaut may be arriving. At the start of the year, all the focus was on the European Central Bank but in early March that has started to shift back to the Fed. The ending of the Fed’s zero interest rate policy is nearing reality as we approach mid-year, and the repercussions are most prominently being played out in the foreign exchange markets with the rise of the US dollar, especially against the euro.

At one point last week, the euro sank to a 12-year low against the dollar; strikingly, the German bund yield curve entered into negative territory all the way out to the 20-year sector.

The triggers for the sudden move are threefold. First, February’s strong US payrolls report confirmed the strong trend of job creation in the US economy that is likely to lift wage inflation, although it has been lagging.

Second, the European Central Bank started its quantitative easing programme,  which cast the spectre of Fed tightening and US policy divergence with the rest of the world as a near-term reality. Third, expectations are growing that the Fed Will remove the word “patience”, in reference to keeping monetary policy accommodative,  at this week’s monetary policy meeting.

The collapse of the euro is probably more a case of eurozone weakness rather than US strength. US growth is moderate relative to previous recovery cycles (real GOP is forecast at 2.8% this year); it is certainly not going gangbusters but is exceeding the eurozone, which is expected to grow 1 .7% this year.

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