The US dollar’s weakness in recent months, despite negative interest rates in Europe and Japan likely had many contributing factors. These factors include shifting views of Fed policy, weaker US growth, the recovery in commodity prices, including oil, gold and iron ore, and market positioning. 

A new phase began in late-April/early May. The dramatic rally in iron prices reversed, and the Australian dollar, bottomed against the US dollar in mid-January, seemingly to anticipate the broader trend weakness.It peaked a week before the other major currencies, including the euro, yen, sterling and the Canadian dollar. 

The US dollar bottomed against a swath of currencies on May 3. The greenback’s technical tone began strengthening seemingly before the fundamentals. However, by time the dollar turned, the US economy was already recovering from the soft patch seen in Q4 15 and Q1 16.

Last week, the combination of constructive data, the FOMC minutes and NY Fed President Dudley, pushed up US interest rates and widened the premium relative to other major countries. The widening rate differentials provided fundamental support for the dollar.

The Federal Reserve succeeded in convincing the market that a summer rate hike was more likely than it previously believed. Moreover, Dudley, who we argue, is part of the Fed’s leadership from which policy emanates, recognized risks posed by the UK referendum, and put the market on notice that although there is no scheduled press conference afterward, a move at the July meeting is also a distinct possibility. 

Although the Federal Reserve has indicated that two rate hikes (rather than four that it envisaged late-December), investors have been skeptical (and more skeptical than economists). Some critics cited this as evidence of the Fed’s loss of credibility. One need not accept the Fed is a slave to the markets, as other critics claim, to appreciate that the gap between the market and the FOMC posed an operational challenge. Under such conditions, the rate hike could be more disruptive than necessary. 

Last week, the Fed regained the upper hand. In the first part of the year, there was often a 100 bp spread between the FOMC’s dot plot and the Fed funds futures strip. The March dot plots in effect cut the gap in half.And now the combination of the recognition that rather than a recession, the US economy is reaccelerating, and the Federal Reserve is committed to opportunistically and gradually normalizing US monetary policy, is prodding investors to move closer to the Fed’s position.