I don't see this dollar rally lasting very long, at least not as long as the current U.S. fiscal expansion continues and I suspect that will be the case all the way until next March. I have been mentioning next March because that will be the time when we're likely see the confluence of two things: The debt ceiling will have to be raised and, most likely, the new president will have already made some policy proposals that will either be passed or voted down by Congress. So the way I see it, next March will be a pivotal time.
Dollar buying now is based on portfolio shifts being driven by two things, both of which, are completely misunderstood.
The first is that the Fed is on a more hawkish policy course while other central banks -- the European Central Bank (ECB), Bank of England (BOE), Bank of Japan (BOJ), etc. -- are still on a dovish policy course. It's understandable that the vast majority of traders want to buy the dollar based on this, but it's wrong. It won't last. If the Fed were to hike rates -- and right now the markets are saying that's a 67.5% probability at the Dec. 14 meeting -- it would be negative for the dollar. I've explained why rate hikes are not bullish for currency but to refresh, they are price increases (inflationary), raise the level of government spending (all else being equal) and constitute the net creation of more dollar assets (i.e. more dollar supply).
Case in point, the dollar index was over 100 last December just prior to the Fed's first rate hike in nine years; a move that constituted a major policy shift. Now it is below that. It was well below that, at 92, several months ago and only recently received a lift from renewed buying on the prospect of this expected rate hike.
The second thing driving the dollar higher is that investors see other currencies as being attached to economies that are weak or weaker. The EU and Europe or, post- Brexit, Britain and the British pound and stubbornly deflationary Japan are seen as weaker.
On the EU and Britain, the policies there are indeed deflationary, but that is not bearish for currency. Indeed, the very concept of deflation -- falling prices -- necessarily means the currency buys more. Its purchasing power goes up, not down, and that is reflected in the foreign exchange rate. Furthermore, the EU is running a trade surplus and Britain is pushing in that direction and likely will come close or even achieve that goal given the pound's post-Brexit vote devaluation.
As for Japan, it might be on the cusp of finally stepping out of its near-three-decade-long fight with deflation as the country has instituted some fiscal expansion this year. If only the BOJ would get out of the way. I think that, ultimately, the fiscal measures will win out and the yen will fall. So with respect to the yen I think the dollar can indeed continue its rise or, to put it another way, the yen will be the weakest of the major currencies.
As for the euro, British pound and Canadian, Aussie and New Zealand dollars, I think they are all going to rise against the U.S. unit. I'd just qualify this by saying the euro faces the most headwinds as the coming year will see the potential for lots of political upheaval in the EU as elections in many states could potentially disrupt the status quo. There are many hard-right or hard-left leaning politicians vying for political power and they could succeed on the anti-Europe, anti-immigration, post-Brexit wave. In other words there could be a lot of "mini-Brexits" all over the place.
Even so that will only slow the dollar's fall against the euro. Bottom line is, I'd be shorting the dollar up here, not buying it.