There are a myriad of factors that impact FX markets and the ebb and flow of investment dollars but breaking it down to the Fed and policy as the only influence can simplify things. In the midst of all the excitement that the Federal Reserve will begin to taper the extreme and extraordinary stimulus measures known as QE, investors are overlooking a key point. The end to QE is an end to easy and cheap money in that form. There is no hint that the Fed is about to raise the benchmark interest rate. So even if the U.S. economy is improving enough that life support can end, the Fed is not going to tighten policy and prevent a full recovery.
But ending QE in the U.S. relative to conditions elsewhere in the world is going to be enough to send the dollar higher as we have seen just from Bernanke mentioning that it is going to end. With an economic recovery and an inflow of investment dollars into the U.S. to buy securities and U.S. assets, the dollar will rise even higher. But when the Fed does finally begin to tighten policy in conventional terms such as raising rates, the dollar is going to break higher again. There may be an interim recession as the business cycle remains, but the outlook for the dollar long term is bullish.