Macroscope | Why the US dollar's recovery has years left to run

The US dollar's turn in fortunes have all the makings of a Hollywood feel-good movie. Its cycle of redemption has seen it recover from the deepest depths of a slide into currency debasement that began in 2009 to regain its place as the darling of the foreign exchange markets.

To the bright-eyed optimist, the fundamentals look almost flawless. Stronger relative economic growth, high interest rate appeal looking forward and attractive bond yield differentials in the United States give the dollar added glow. Solid inward investment flows into the nation's surging capital markets and its growing self-sufficiency in energy needs add to the dollar's stature. A 10 per cent rally since May has not been without good cause.

Economic growth is vital to the dollar's reversal of fortunes. The US has seen much faster growth than other countries in the past five years, thanks to the Federal Reserve's early start on returning the economy to health with huge infusions of super-easy money. The Fed's quantitative easing injections initially sank the greenback by over-flooding the markets with cheap dollars, but eventually secured enough traction to propel the economy into durable recovery.

Thanks to the easing, the US is now enjoying underlying growth running upwards of 3 per cent, while Japan has slipped into recession and the euro zone is stuck with stagnation and deflation.

Relative interest rate factors double the dollar's appeal. With the economy moving into its sixth year of solid expansion, it is no surprise that the Fed has shifted into a tightening bias and is expected to raise rates by April next year. US interest rate futures contracts show investors believe rates will rise above 3 per cent over the next four years.

Meanwhile, the euro zone and Japan could be stuck with zero interest rates for years to come considering their dismal domestic outlooks. Euro-zone rates could dip even further into negative territory in the interim, a factor which could seal the single currency's return to parity against the dollar.