Here's Why The Dollar Is So Strong

Relatively strong U.S. economy. Our economy has been outperforming most international economies in recent years—especially the developed economies that are our biggest trading partners in Europe and Japan. A relatively good (even if not great) economy has helped boost U.S. financial markets and made the U.S. a more attractive destination for foreign capital.

Improving trade balance. The U.S. trade balance has improved dramatically, thanks in large part to the boom in U.S. energy production and resulting drop in oil prices that has reduced U.S. imports and increased exports. By keeping more dollars here at home, a smaller trade gap is bullish for the dollar.

Improving budget deficit. The measures that the United States has taken—in some cases painfully—to reduce the deficit by cutting spending (remember the sequester) and increasing taxes (remember the fiscal cliff) have reduced the U.S. federal deficit from as high as 11% of gross domestic product (GDP) in 2010 to about 3% as of the end of 2014. By strengthening the U.S. balance sheet, a shrinking budget deficit is bullish for the dollar.

Higher interest rates relative to developed alternatives. The 10-year U.S. Treasury yield, at 1.80% as of January 23, 2014, has been more than cut in half over the past five years. Still, it is much higher than the equivalent yields in Europe, where the German 10-year bund yield stands at 0.36%, and Japan, where the 10-year Japanese government bond (JGB) yields 0.22%. Higher interest rates in the United States have made U.S. bonds more attractive to foreign investors and enhanced the attractiveness of the dollar.