Dollar strength, global weakness, and Fed behavior

The dollar strength is a major trend because there is little stopping the current divergences in monetary policies across central bank. The dollar strength is clearly associated with a favorable growth differential versus Japan and the EU which drives policy action. The current dollar strength is consistent with the end of QE3 and the anticipation of a rate increase in 2015. Aside from technical factors, the key dollar trend risk is that the Fed does not follow through with its current direction toward tightening. A delay in the expected rise in rates will be dollar negative. 

Policy differentials drive currencies, but we also have to look at alternative stories. Dollar strength also has been associated with US and world recessions. A recession causes a flight to safety into the reserve currency, the dollar.  If the current dollar trend continues, the dollar will push close to financial crisis highs when there was a flight to safety coupled with loose monetary policy.  Hence, an alternative story for dollar strength is that it is signaling a flight to safety given slower growth expectations. We also know that dollar strength places pressure on emerging markets through dollar funding pressure.  Dollar strength has also been coupled with lower oil prices; however, the lower dependence on oil imports makes this story less likely. 

Flight to safety and global weakness seem to be key forces to further push the current dollar trend. The question to be faced by the Fed is whether it should act on this weakness and safety flow and show further "patience" with any rate rise. Fed decisions on its relationship with the global economy may be more important than any policy action with respect to labor markets.