As American economy roars, US dollar soars

What's driving the dollar?
What's driving the dollar?   

The American economy is continuing to beat expectations, especially relative to the performance of many economies around the globe. And that's sending the U.S. dollar surging.

On Tuesday, the Commerce Department announced that in the third quarter, gross domestic product rose at a seasonally adjusted annual rate of 5.0 percent, nicely above the earlier estimate of 3.9 percent. Consequently, the U.S. dollar index, which compares the U.S. dollar to a basket of six currencies, jumped to the highest level since April 2006 on Tuesday.

Read MoreUS third-quarter growth revised up to 5%

Good economic news always tends to boost a nation's currency, but that is doubly true in the current environment, as the Federal Reserve is widely expected to raise short-term rates in 2015. Generally speaking, the better the economy, the sooner the Fed is likely to raise its federal funds rate target. And greater short-term rates would make it more attractive to hold dollars rather than other currencies.

Expectations of an earlier Fed move could certainly be sensed in Tuesday trading. The yield on two-year Treasury notes rose to the highest level since April 2011 after that GDP report.

By the work of Michael Block, "This yield is telling you that the market is nervous or expectant about a rate hike next year," the chief strategist at Rhino Trading Partners wrote in a Tuesday note to clients.


Andrew Harrer | Bloomberg | Getty Images

Of course, the impressive U.S. economic number and expectations of dollar-bullish Fed action come as much of the world is headed the other way. Growth around the globe generally looks stagnant at best, and monetary authorities like the European Central Bank are looking to ease policy further in order to spur economic growth and fight the prospect of deflation.

"Today's GDP just underscores that on a relative basis the U.S. just looks very good, and all the stars are really aligned for the dollar," said Camilla Sutton, chief currency strategist at Scotiabank. "Not only do economic and fundamental data continue to surprise in terms of their divergence from other places around the world, but the Fed increasingly seems like one of the few central banks that will hike rates in 2015."

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The one potential issue is that the bullish dollar trade is so deeply ingrained in the market consensus.

"It's very, very hard to find anyone who's willing to talk about being a dollar bear, and it is a concern when you can't find someone on the other side of a trade," Sutton said, adding, "But currencies have a way of trending for long periods of time, and it certainly seems that there's still more upside for the dollar here."

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