Self-destructive tendencies

Dollar strength is biggest risk to strong dollar

The dollar is on a roll. It has been a dozen years since it was last this close to parity against the euro - it fell below $1.05 on March 12 - or this strong against a traded basket of currencies. The greenback's upward momentum is so strong that self-sabotage is the main risk.

The broad-based rally has solid foundations in monetary policy. The relatively strong American economy has made the US Federal Reserve the only major central bank expected to tighten policy this year. So, little wonder that options prices for most major exchange rates show investors have a marked preference for buying dollars over the next 12 months.

Granted, the rapid gains of recent days leave a lot of space for temporary setbacks or periods of range trading. With so many big bets that the US currency will keep rising, any hints of bad economic news or second thoughts at the Fed can trigger short-lived scrambles. And bouts of profit-taking from time to time are inevitable.

But the strong dollar is itself the greatest threat to the dollar rally. A strong currency makes US exporters, including IBM and Hewlett-Packard, less competitive and hurts reported profits at companies with big foreign operations. Policymakers may not care about currency translation rates on financial statements, but exporters' jobs could be another matter.

The minutes of the Fed's January policy meeting merely noted the drag on exports from exchange rate moves. Granted, the effect on the large and relatively closed US economy would be limited. Still, the dollar index has risen nearly five per cent since then and gained about a fifth in value since August 2014.

Any hint that the Fed is becoming less indifferent would deal a real setback to the dollar rally. Traders will be reading the runes especially carefully after the March 17-18 policy meeting.