'Nuanced' Q4 dollar gains as monetary policy diverges

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The divergence in global monetary policy - as the Federal Reserve prepares for its first rate hike in mid-2015 while counterparts in Japan and Europe consider adding stimulus - will drive the U.S. dollar higher this quarter, a CNBC survey of currency strategists and traders shows.

The rise of the dollar index – a gauge of the greenback's value against a basket of six major currencies – has been virtually unassailable, racking up gains for a record 12 straight weeks – its longest winning streak since its 1971 free float under President Nixon.

"We expect a strategically strong dollar over an extended period measured in months and years," said David Kotok, chief investment officer at U.S. money manager Cumberland Advisors with $2.3 billion in assets under management. "Our central bank is at neutral and unlikely to revert to QE (quantitative easing) again. The rest of the world has not reached that stage."

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Kotok is not alone. Eighty one percent of respondents expect the greenback to set new highs, while just under a fifth believes the rally will fade.

In a research report on September 30, Deutsche Bank flagged the dollar's ascent as a major headwind for the commodities complex and predicted that the move has further to go.

"A new long-term uptrend in the U.S. dollar is now firmly entrenched and will continue to pose risks to large parts of the commodities complex," Deutsche Bank strategists said in their Commodities Quarterly. "On our reckoning we are only half way through the current U.S. dollar cycle in duration and magnitude terms."

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Fed policymakers last month indicated that they expect faster rate hikes next year and the year after. The central bank in its mid-September meeting pushed up its expected path of interest rate increases – the so-called Fed 'dots' forecast. That's likely to set the tone for further dollar gains, though yields on U.S. treasuries - on short and medium-dated notes - suggest the bond market remains unconvinced.

"For Q4 we believe U.S. economy remains on track which means market's rate expectations will move to align more closely with the Fed's 'dot' forecasts," said Vassili Serebriakov, currency strategist at Wells Fargo. "The USD should remain supported, and we see EUR/USD at 1.25 and USD/JPY at 112 by the end of Q4."

A bit stretched

Still, some argue the rally risks exhaustion towards year-end after such a blistering and historic run. The dollar index rose to a four-year peak at the start this quarter, boosted by upbeat U.S. jobs data on October 3.

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"[The] dollar has scope for continued upside but the move is getting a bit stretched and may become more nuanced into the year-end," said Ilya Spivak, Currency Strategist at FXCM Live.

Nick Bennenbroek, head of currency strategy at Wells Fargo, said 'corrective weakness' was in store for the U.S. dollar: "While the Fed is moving closer to tightening, policy action is not imminent just yet. Against the backdrop of current market positioning, that provides some scope for the U.S. dollar to soften."

Meanwhile, dollar bears emphasize that the currency's headlong rush higher is at odds with economic fundamentals. "The strength in the U.S. dollar doesn't necessarily reflect underlying economic strength," said Gavin Wendt, Founding Director & Senior Resource Analyst at Sydney-based Mine Life Pty. "The market is being misled with respect to potential Fed interest rate increases - I can't see the Fed raising interest rates in mid-2015 as the economy won't support it."

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The dollar index (DXY) hit a high of 86.74 on Friday - its strongest level since June 2010 - and rose 7.7 percent in the third quarter. That's its largest percentage increase since a 9.6 percent gain in the comparable period in 2008.