The resurgent US dollar hit a new nine-month high of $1.203 against the euro yesterday amid expectations of an ever-widening yield differential between the world's two largest economies.
Comments last week from Alan Greenspan, the chairman of the Federal Reserve, that the US economy was on a "reasonably firm footing" allayed fears of an imminent pause in the Fed's tightening cycle.
The Fed has raised its repo rate at each of its last eight meetings, and the futures markets are now pricing in three more rises this year, taking US short-term rates to 3.75 per cent. In sharp contrast, mounting economic gloom in the 12-nation euro zone has fed market expectations that the next move from the European Central Bank, which has held rates at 2 per cent for the past two years, will be to cut rates.
These flames were fanned further at the weekend when Otmar Issing, the ECB's chief economist, said that in the past financial markets had almost always correctly forecast the ECB's intentions, implying that a rate cut was indeed on the cards.
As a result, the yield spread between 10-year US and eurozone bonds has risen to 90 basis points, its highest level since March, during which time the dollar has risen 10.7 per cent against the euro.
"Any kind of shift in direction from the ECB is important because they have been extremely reluctant to acknowledge any possibility of an easing move," said Jens Nordvig at Goldman Sachs, which yesterday revised its euro forecasts downwards for the second time in two weeks, now seeing the euro falling to $1.15 in three months' time.
The US trade deficit, perhaps the key factor in the greenback's three-year decline, may finally have stabilised in the $56-$58 billion range following the release of better-than-expected April data last week.
Big banks are also increasingly reporting large repatriation flows by US multinationals under the auspices of the Homeland Investment Act, a year-long tax break designed to encourage US companies to bring home earnings held abroad.
JP Morgan believes US companies will repatriate $100 billion (€83 billion) before the end of the year, most of which would be converted from euros.
