Strong Dollar - An Inflated Currency in a Deflated Global Economy by Kampamba Shula

With flexible exchange rates and wide-spread abandonment of capital controls the dollar is largely free to move up or down as market forces dictate
In this framework it is reasonable to infer that any observed weakening or depreciation of the dollar is most likely the result of a reduced demand for dollars in the foreign exchange market, an increased supply of dollars in that market, or some combination of both forces. Similarly, an appreciating, or strong dollar, is the consequence of an increase in the demand for dollars, or a decreased supply of dollars, or both in the foreign exchange markets.
The volume and speed of international asset transactions far exceed those of goods transactions. This means that at any point in time it is most likely that the relative demand for assets here and abroad will be the dominant force in the foreign exchange market, transmitting the essential energy that drives movement in the exchange rate for the dollar and other widely traded currencies.
Expectations about the future path of the exchange rate itself will figure prominently in the investor’s calculation of what she will actually earn from an investment denominated in another currency.  Even a high nominal return would not be attractive if one expects the denominating currency to depreciate at a similar or greater rate and erase all economic gain.  On the other hand, if the exchange rate is expected to appreciate the realized gain would be greater than what the nominal interest rate alone would indicate and the asset looks more attractive.
There is also likely to be a significant safe-haven effect behind some capital flows.  This is really just another manifestation of the balancing of risk and reward by foreign investors. Some investors may be willing to give up a significant amount of return if an economy offers them a particularly low risk repository for their funds. In recent decades the United States, with a long history of stable government, steady economic growth, and large and efficient financial markets can be expected to draw foreign capital for this reason.
The greenback is trading at a 12-year high against the euro and 8-year high versus the Japanese yen. This strength is, in many respects, a sign that the economy in the United States is much healthier than Europe, Japan and many other parts of the world. The strengthening of the USD in recent times has caused some element of volatility in the currency markets across the globe and almost all emerging markets' currencies have been affected on this score as they have tended to depreciate.
The US Federal Reserve has withdrawn the QE completely on the premise that the economy is picking up and that unemployment levels are low and within acceptable limits. This indicates that the economy is going to record a healthy growth rate from 2015 onwards. Also, interest rates are expected to increase in mid-2015 with the Fed tracking the inflation numbers.
Quantitative easing meanwhile continues to be dominating the economies of Japan and the euro region with China is also showing signs of easing rates. Any kind of affirmative action to revive an economy is taken to mean a weak economy and by implication a weak currency. This has propped up the USD which appears to be the strongest currency today.
Diverging central bank policy has created a perfect launch pad for the dollar to move higher, particularly against the euro. The Fed is expected to push interest rates higher in the next several months, while the European Central Bank embarked on a quantitative easing bond buying program recently. Some analysts expect the Fed to hike rates in September. The currency-weakening moves by the SNB, ECB and others across the globe have spurred talk about a renewed currency war as countries adopt a beggar-thyneighbor policy to spur growth.
Generally, the financial health of a country, as measured by deficits and debt and forecasts of deficits and debt accumulation, plays an important role in driving the relative currency valuation of a particular country. Countries that have chronic deficits and growing debt burdens ultimately end up in a weaker position in the foreign exchange markets, albeit sometimes with considerable lag times.
The present strength of the dollar is temporary and can also be seen as the penultimate stop in a flight to safety. When the next financial crisis unfolds as it surely will gold, precious metals and even structured alternatives like bitcoin are likely to be the next and last stop.
Predicting the path of the dollar is always a problematic endeavor.  Economic fundamentals predict that the dollars near-term path will broadly reflect the resolution by international investors of an ongoing balancing of risk and return.
Economic growth in the United States in 2014 showed signs of recovery and this may have translated into an increase of the expected return on dollar assets. In addition, the Fed is expected in mid-2015 to increase short-term interest rates. In contrast, both the euro area and Japan have demonstrated that they have firmly established economic contractions underway, and they have currencies that are not expected to appreciate. These changes suggest that the expected yield advantage of dollar assets has been strengthened. If so, this presents foreign investors, with an already strong need to diversify into dollar assets of an attractive sustained and safe rate of return. This change in incentives could be sufficient to induce a significant move away from yen and euro assets.
The US dollar is expected to appreciate over the near term against major convertibles. The reason for this is mostly down to a global monetary policy divergence between the U.S and the rest of the world. With the EU and Japan fighting deflation using QE, they are inadvertently propping up the Dollar.
This appreciation of the Dollar though due in a small part to stronger US growth is at the most part an inflated effect of deflated global economy. A disorderly adjustment is probable, but not inevitable.

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