Investment Bible, Lesson One: whenever universal agreement is reached, the opposite soon follows. So it seems for the dollar. A month ago, America’s currency was written off by everyone. The widespread view was that a double digit fiscal deficit and a bloated Federal Reserve balance sheet spelt trouble. Inflation was imminent. The financial hegemony of the US was over.

But the dollar has stopped listening. Since the beginning of December, it has risen seven cents against the euro. It is also up almost 5 per cent versus the yen, itself no slouch lately. Also in retreat are the commodity currencies such as the Australian dollar. These are not gigantic moves. Still, all told, it has been the biggest monthly rally in the dollar on a trade weighted basis since February.

What is going on? After all, the arguments for the dollar’s longer-term decline have not changed. Four reasons jump out. First, US bond yields are ticking up: for example, by 30 basis points on 10-year Treasuries since November. Second, (and partially related), positive econommic data has some economists lifting America’s growth prospects next year versus other countries. Third, the US’s balance of payments will fall to 1.4 per cent of output next year, according to Morgan Stanley, from almost four times that today. Finally, US policy makers such as Fed chairman Ben Bernanke seem to be talking up the dollar with a tad more urgency.

Fair enough. But where investors could get it wrong is on interest rates. Yields are rising partly because of the expectation that quantitative easing will end early next year. But over 2009 the Fed bought roughly the same amount of long-term securities as the $1,500bn issued by the Treasury. Ending that in a hurry could push rates higher – so the Fed may delay. Careful before chasing the dollar.

Post a comment below or e-mail the Lex team confidentially

Copyright The Financial Times Limited 2018. All rights reserved.