The mighty dollar is likely to remain a major talking point across financial markets after leaping to its highest level this year against a basket of major currencies.

It’s a remarkable and somewhat frightening change of sentiment given that dollar weakness was a dominant market theme at the start of 2018. Low U.S. inflation fears, heightened political uncertainty in Washington and fading rate hike expectations initially weighed heavily on the currency.

However, the aggressive appreciation witnessed in recent weeks suggests that dollar bulls are back with vengeance and on a mission to rattle currency markets. This bullish price action suggests that improving economic data from the States, surging U.S. bond yields and rising inflation expectations have boosted buying sentiment towards the dollar. With markets now speculating that the Federal Reserve will raise interest rates at least twice (and possibly three times) by the end of 2018, dollar strength could remain a recurrent theme.

Thanks to a hawkish Federal Reserve, interest rate differentials are clearly moving in favour of the dollar. Stubbornly low levels of inflation and disappointing economic data from Europe have heavily weighed on expectations of an ECB rate hike in 2019. The BoJ is expected to maintain its ultra-easy monetary policy, while easing inflation - coupled with a cautious Mark Carney - has reduced the likelihood of a BoE rate hike anytime soon.

The Federal Reserve is the most hawkish major central bank that is poised to tighten monetary policy this year – this the key to understanding why interest rate differentials continue to heavily support the Greenback.

It is worth noting that the recent oil rally is likely to stimulate market speculation over rising U.S. inflation - ultimately supporting Fed rate hike expectations. The dollar’s incredibly bullish price action continues to highlight how sensitive the currency is to monetary policy speculation. With the Federal Reserve expected to raise rates and shrink their balance sheet this year, the Greenback could be poised to scale fresh heights in 2018.

Although the dollar is en route to turning both technically and fundamentally bullish, risks in the form of Donald Trump and wider geopolitical tensions could present some obstacles down the road. It must be kept in mind that Donald Trump has repeatedly exhorted the need for a softer dollar in order to support U.S. exports and reduce the trade deficit. Markets will most likely pay very close attention to what action Donald Trump takes if the dollar continues to appreciate. While there is a possibility of Trump verbally intervening and “talking down” the dollar, the fundamental drivers behind the upside have the ability to limit downside losses.

Taking a look at the technical picture, the Dollar Index remains heavily bullish on the daily charts. It will be interesting to see if the upside momentum sends prices to 95.00, levels not seen since October 2017.

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