The hottest trade of the past two months has been a surprising one: Going long the U.S. dollar against other currencies. And the recent dollar strength appears to have had a profoundly negative impact on commodity prices.
Since the end of June, the U.S. Dollar Index (which compares the dollar to a basket of other currencies) has risen 3.5 percent, bringing the index to a 52-week high. And while the weakness in the widely watched euro has certainly contributed to the move, the dollar has also shown considerable strength against currencies like the British pound, the Canadian dollar and the Japanese yen. On Tuesday alone, the dollar rose 0.7 percent against the yen—a serious move for a major currency.
Many expect the European Central Bank to announce easing measures this week, and this expectation is likely contributing to euro weakness and thus dollar strength. But because the move is so broad-based, it can't all be credited to ECB President Mario Draghi.
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"This is much more about the widening gap between the U.S. economy and economic performance in the rest of the world," said Kathy Lien, managing director of FX Strategy at BK Asset Management. "In the U.S., we're seeing a widening divergence between economic growth and monetary policy outlook," which should ultimately lead interest rates to rise. "And as we get more discouraging news from Japan, from the euro zone, etc., that will also boost the attractiveness of the U.S. dollar."
The dollar rally certainly hasn't been celebrated by commodity bulls, who saw gold hit a 2½-month low on Tuesday, and crude plunge by more than 3 percent. Broadly speaking, commodities tend to move inversely to the dollar. This makes sense, given that as each dollar becomes worth more, it should take fewer of them to buy the same amount of hard assets. Most commodities are priced in U.S. dollars.