The FT on the Dollar and the US Deficit

Brad Setser points us to a lead article in the FT argues dollar strength (v. Europe and Japan) can be sustained for several more years. Brad, of course, is rather critical of the piece, while I think it argues exactly the view I have been putting forward for some time now.(Incidentally I don't think it is quite right to say that "the FT is no longer worried", better put, the FT is facing up to reality, a reality that Brad doesn't like, and that worries both me and the FT in the long term).

For a currency that most experts predicted would fall this year, the dollar is in remarkably good shape. This week the US currency hit two-year highs against both the euro and sterling....

Until March this year, the focus was on the current account deficit, and the dollar steadily declined against those of its trading partners with floating exchange rates, notably the euro and sterling. But since spring the focus has shifted to the interest rate story, with the dollar rising against these two currencies and the Japanese yen....

Movements in short-term interest rates alone cannot explain large shifts in currencies. However, since the start of the year, the long-term interest rate differential has also moved in the US's favour, across the entire yield curve and against all its peers. This largely reflects better news on economic growth in the US than elsewhere......

None of this means that the dollar can forever escape the consequences of the current account deficit. The deficit is not sustainable in the long run, it will eventually narrow and this will require further overall depreciation of the dollar.

But a long-term requirement does not make a certain short-term bet. The current account dynamic may not bite for several years yet. In the meanwhile, there is nothing to prevent the dollar enjoying lengthy periods of strength.

I couldn't have put it better myself :).