Expectations that the US Federal Reserve will increase interest rates later this year, when they are set to remain on hold elsewhere, has been the key factor driving the dollar higher.
Indeed, further monetary easing across the globe in recent months highlighted the emerging difference between the stance of monetary policy in the US and elsewhere. Nowhere is this contrast more evident than with the eurozone.
The euro has lost considerable ground over the past year as the persistence of very weak growth there, coupled with a fall in inflation to very low levels, forced the ECB into further policy easing. This culminated in the launch of a full-blown quantative easing (QE) programme this year.
Key exchange rates have moved out of well-established trading ranges in 2015, while there have been big currency moves over short periods of time.
The euro/dollar rate fell from around €1.25 in mid-December to a 12-year low of €1.05 in mid-March. Similarly, the euro fell through the key support level of 78p versus sterling at the start of the year, declining to close on 70p.
Another noticeable feature of FX markets this year has been increased volatility, in part, related to central bank policy changes. The ECB’s move to full-blown QE has weighed heavily on the euro.
Meanwhile, surprise easing announcements from central banks such as the Bank of Canada, Reserve Bank of Australia and the Swedish Riksbank resulted in a weakening of their respective currencies.
The SNB caught markets completely off guard with the shock decision to discontinue the policy of capping its currency’s exchange rate against the euro, resulting in sharp appreciation of the Swiss franc.
Clear forward-guidance on interest rate policy from the US Fed and Bank of England has also come to an end.
As a result, there is much greater uncertainty about the future paths of interest rates in both countries.
It is clear that monetary policy decisions will be heavily influenced by incoming economic data, especially in the US, where the Fed is closer to hiking rates than the BoE.