The dollar has been one of the strongest currencies during 2013 and has bucked a trend that has existed over the past three years. As the debt crisis unfolded in the spring of 2010, investors flocked to the dollar as a safe haven currency. The risk on/risk off environment generated a choppy market for currency traders, but that phenomenon seems to have ended.
Despite a strong move in most of the developed markets equity bourses, which has historically been considered a risk on environment, the dollar has flourished moving higher versus the Yen, the Aussie, the Canadian dollar, the Pound and the Euro. Generally interest rate differentials guide long term movements in the currency markets. This would lead one to believe that a zero interest rate policy, which is currently the monetary policy in the US, would create headwinds for the dollar - but it has not.
The dollar has been strong because investors perceive that economic weakness in other developed countries will last longer than economic weakness in the US. Japan has been weak for decades but has recently embarked upon a quantitative easing program that goes beyond that of the Federal Reserve. Economic data in Europe shows that most of the countries within the EU are close to or already in recession. Australia has just started to cut interest rates, but the recent weakness seen in China is likely to lead Australia into further contraction.
The UK represents an interesting case. Despite recent strength in employment and retail sales, manufacturing and growth are lackluster. The UK has always had an issue with inflation, but the recently decline has given the Bank of England an opportunity to reduce rates. The issue here is that a new governor will be heading up the Bank of England in the second half of 2013. Mark Carney, the central banker who currency heads the Bank of Canada, is slated to take over in June. He is considered a hawk but is expected to achieve more flexibility with monetary policy than the BoE currently has from the UK government.
The largest moves the dollar has experience in 2013 are the gains against both the Australian dollar and the Japanese yen. Gains against the Aussie greenback have been recent, as economic growth estimates have been downgraded by the Reserve Bank of Australian following a cut in interest rates by 25 basis points. The gains seen against the yen started in the last two months of 2012, and have continued into 2013 as the Bank of Japan has ratcheted up their quantitative easing program. With the Bank of Japan likely to continue to boost their accommodative policy, the dollar will remain strong and should remain the currency of choice throughout 2013.