Policymakers are flummoxed by the dollar. Too strong and US goods and services become uncompetitive; weak, and it reflects poorly on policy. Year to date, the dollar index is about 1 per cent higher against a basket of global currencies and nearly 8 per cent stronger over the last 12 months.  Several markets take their cues from the dollar: US small caps tend to outperform large caps with dollar strength, while emerging market equities tend to benefit from a wilting greenback.

Several factors influence the direction of the dollar: the relative attractiveness of US real (inflation adjusted) interest rates and the relative strength of the US economy. US bond yields, while low by historical standards, yield-wise stand head and shoulders above most developed-world sovereigns. The German 10-year Bund offers a paltry 0.05 per cent yield while the Japanese 10-year JGB yields -0.05 per cent. The relative strength of the US economy is another factor in the dollar’s corner. Yes, the 2.6 per cent annualized growth registered in Q4/18 GDP was a letdown, but it dwarfs growth in most corners of the developed world. The Eurozone delivered a scant 0.2 per cent growth last quarter while the German economy was flat. Purchasing power parity, the relative value of like goods and services translated into various currencies, shows the dollar is probably too strong relative to the euro, yen, pound and loonie, suggesting the dollar has likely run too far. A further deceleration of US growth could compound that effect. This means that small caps’ outperformance could give way to emerging market relative strength in the coming quarters.

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