Diverging central banks will power dollar in 2017

Donald Trump is promising more US government spending. The coming year will also most likely see tightening Federal Reserve policy, too. That contrasts with continued weak growth and loose monetary conditions in the euro zone and Japan. This divergence between central banks will help the dollar get even stronger against most other currencies.
The effect has been clear since Trump won the US election on November 8. The Japanese yen, for example, has fallen more than 10 percent against the dollar in just over a month. The Chinese yuan is slightly weaker as are the euro and the pound. One factor is that America's economy is expanding faster than the European Union or Japan. But central banks also have a lot to do with it. After years of buying bonds in an effort to ease financial conditions and rekindle inflation, the Bank of Japan's balance sheet has swollen to around 90 percent of the country's annual output.
Though the Fed's stash of over $4 trillion is similar in absolute size, it's closer to a more modest 25 percent of GDP. Moreover, BoJ Governor Haruhiko Kuroda is committed to buying as many bonds as needed to keep Japanese 10-year government bond yields at around zero. By contrast, Fed Chair Janet Yellen and her colleagues are likely to raise rates further in 2017.
Meanwhile the European Central Bank, with another giant balance sheet, has pledged to continue buying tens of billions of euros' worth of bonds until the end of 2017. A currency offering higher yields should, other things being equal, be a stronger one. The best such correlation currently in evidence is between the yield on 10-year Treasuries and the dollar-yen exchange rate, according to analysts at Brown Brothers Harriman.
Analysts at Deutsche Bank see a "perfect storm" brewing for US dollar strength, with the euro falling below parity by the end of 2017 from about $1.04 in mid-December, and the yen losing further ground.
That scenario may be too extreme. A rising greenback and tighter Fed policy could blow back to squelch US exports and growth, as might any economic trouble abroad. Even so, the pressure to appreciate will persist as long as the US central bank is at odds with global peers.