The rising dollar – what’s driving it and will it continue?

The rebound in the dollar is looking increasingly over-extended. Shifting interest rate differentials are still the most common explanation of recent dollar moves against the euro. But these cannot explain why the dollar remains well above the levels seen in mid-2005, since rate expectations in the US and the euro-zone have largely moved in parallel since early September. What’s more, to the extent that interest rate differentials do matter, expectations are now shifting in favour of the euro in response to dovish Fed comments and a more hawkish ECB.