US dollar rose about 1.7% against a basket of major currencies in the past two weeks, trading near five-week highs against the euro and 2-1/2 month peak versus the Australian dollar. Dollar strength did not stem from strong US economic reports, but from weaker numbers from other economies.

While investors have priced in a US recession, many are still too optimistic about the economic outlook for other countries. The latest batch of weak numbers, including declining business and consumer confidence in the euro area, falling retail sales in the UK and Germany, and a contraction in the May GDP in Canada etc., suggested that there could be no decoupling. These countries are not immune to a US slowdown. As US interest rates are already at low levels, there is little room for the Fed to act. In contrast, interest rates in the UK, Australia, New Zealand, and even the euro area could come down.

In addition to shifting interest rate expectations, lower crude oil prices also helped support dollar sentiment. The price of crude is already down about over USD20 compared with its peak of USD147 on July 11. Gold and other commodity prices have followed. The US dollar has gained about 3% against the Australian dollar. The performance of the New Zealand dollars was even worse. It is trading near 10-month lows versus the greenback. With its economy close to recession, the Reserve Bank of New Zealand looks set to reduce rates further.

Looking ahead, interest rate expectations and the price of crude are likely to remain key drivers for the dollar. With more central banks being forced to reduce rates as their economies slow, the dollar rally could persist, provided of course, the price of crude stabilizes.

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