The US currency is riding high, trading at its strongest levels since May 2017 based on the DXY dollar index. In particular, the dollar has pushed to a near two-year high against the euro. The latest burst of dollar appreciation against the euro has been fueled partly by a surprise drop in German business morale and political uncertainty in Spain ahead of an election.

But we believe recent movements in the US dollar also underline a shift in the longer-term behavior of the currency. Traditionally the USD has outperformed in the best of times and the worst of times – either when the US economy is doing exceptionally well relative to the rest of the world or when global risk aversion drives investors to the safety of the US. Now we think the USD is likely to depreciate when the global economy improves and also when global investors become more risk averse.

We see a number of reasons for this personality shift:

* The Federal Reserve has more room to cut rates than its peers if global growth slows and risk aversion increases. While the upper bound of the Fed funds rate is 2.5%, the ECB's deposit rate is –0.4% , the Swiss National Bank's benchmark is at –0.75% and the Bank of Japan's policy rate is –0.1%. As a result, the US dollar would likely be hurt if central banks are forced to move conclusively back into easing mode, since the Fed can trim rates more easily.

* Yet the dollar could likewise be undermined by a notable acceleration in growth, as this would allow the ECB, SNB, and BoJ to tighten. Since the Fed already appears to be near the peak of the cycle, this would close the rate gap and promote a convergence at the long end of the yield curves. We think this would also diminish one of the USD's main sources of strength.

* Only a benign environment where global central banks tread water and yield differentials remain static (i.e. the status quo) would be US dollar-supportive.Since we anticipate some improvement in global growth, we expect US dollar strength to decline over the coming year, particularly versus the euro. We have a 12-month forecast of EURUSD 1.2, versus 1.11 at present. We think the USD will remain strong against the Swiss franc, partly because the Swiss National Bank will lag the European Central Bank’s rate hiking cycle. But over a multi-year horizon, we expect CHF also to rise and so recommend Swiss investors to hedge USD assets.