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The dollar’s good cheer after Fed interest rate hikes yesterday, disappeared on Wednesday. The dollar had seen its highest gain against the yen in three weeks following the Fed’s announcement of taking interest rates to 4.75 percent. Fed Chairman Ben Bernanke has hinted at further interest rates to come. However, those gains were erased today on remarks by a senior Treasury official asking China to further appreciate its currency.

Rate increases make the dollar more lucrative to investors. The Fed has raised interest rates 15 times since June 2004. The current interest rate is 4.75 percent which is more than the 2.50 percent in the euro zone, Britain’s 4.50 and Japan’s zero. Euro zone rate are predicted to increase this summer.

A strong trade surplus is boosting the Chilean peso to new heights. The currency was at its highest in seven weeks against the dollar on Thursday. High prices of copper have been the major contributor to the $930 million trade plus. Copper is Chile’s primary export and exports account for more than a third of Chile’s gross domestic product.

The trade surplus is at 3.5 percent currently. Interest rates in the Latin American nation have stayed put for the past two months due to a strong currency. The country’s economy which expanded 6.3 percent last year is expected to continue growing at a rate of 5.5 percent to 6 percent. The peso has gained 9.9 percent in year.

Earlier this week, Japan released a slew of economic data, all of which underscore the likelihood of future rate hikes by the Bank of Japan. First, Japan announced that annualized GDP growth for Q4 exceeded 5.5%, which exceeded growth in both the US and EU. Further, Japanese prices increased by 1.6% on an annualized basis, which indicates Japan seems to have finally escaped from the throes of deflation. If growth and inflation numbers continue to exceed expectations, you can assume Japan will begin raising rates by the end of this year. Currency traders are already beginning to build models around such interest rate hikes, all of which favor the Yen.

Read More: Yen tumbles on fresh deflation fear

Time for some cheer! The dollar gained against most major currencies on Thursday following some strong economic data from unexpected quarters. The US housing market saw sales of previously-owned homes gaining in February. House re-sales were up by 5.2 percent as against predictions for a decline.

This has once again reversed the train of thought on interest rate hikes. The dollar has gained 1.8 percent this week after poor performance the whole of the last. More and more traders are leaning towards interest rates touching 5 percent this year. The greenback has been under pressure as the ECB and Bank of Japan move towards interest rate hikes, thus reducing the allure of the dollar to foreign investors.

Inflation in the United Kingdom stayed below the 2 percent target set by the Bank of England for January. This has led to investors predicting a reduction in interest rates. Inflation was popularly expected to touch at least 2.1 percent. Indications that consumer spending may not rebound sufficiently enough to raise growth from a 13-year low is more reason to believe a cut in interest rates may be on the anvil.

Prices dropped 0.5 percent for the same period with furniture and household equipment leading the way. Clothing and footwear followed close behind with a fall of 4.1 percent. Inflation would have been lower if energy and transport prices had not soared. Cost of transportation increased 0.5 percent. Bloomberg reports:

“The figures continue the recent run of reports suggesting that underlying inflationary pressures remain muted,” said Nick Kounis, an economist at Fortis Bank in Amsterdam. “They suggest the bank does have room to cut rates if growth disappoints going forward.”

Over the past few years, the failure of the USD to decline in response to soaring trade deficits has baffled economists, leading some to propose that the only reason the USD has not depreciated is foreigners’ continued willingness to finance the deficits. A new theory, however, is quickly gathering support among economists. It suggests that the common interpretation of current account deficits is unreasonable. Basically, a significant portion of US trade takes place between US companies and their foreign subsidiaries. A change in exchange rates, thus, would not cause much of a change in trade patterns. As a result, a rising current account deficit may not be as large of a problem as has long been argued, as a decline in the USD would not produce a significant drop in the deficit. Reuters reports:

One reason put forward for the growing impotence of currency rates in synching trade accounts is that national trade statistics disguise the real nature of trade flows.

The Australian dollar saw its biggest loss in three months on concern the nation’s high interest rates will soon fail to attract investors. Borrowing costs are climbing around the world. The currency lost 1.5 percent this week as interest rates in Australia stayed at 5.5 percent. The US Fed is expected to increase interest rates a few more times this year.

The Bank of Japan has indicated it might also soon start increasing rates. These developments are likely to keep the Australian dollar low for some more time. A report indicating increased employment had helped the currency earlier this week. But that trend has been short-lived.

This week, an article in the Wall Street Journal insinuated that the Fed would likely raise interest rates only one more time, if at all. The article, which incorporated both economic indicators and economists’ sound-bites, caused a minor stir in forex markets, as traders tweaked their models to account for the change in expectations. The latest consensus, which is also reflected in interest rate futures, is that the Fed will raise interest rates in May, for the final time in its current cycle of monetary tightening. Furthermore, such futures also indicate a low likelihood of an encore rate hike in June. Marketwatch reports:

Meanwhile, persisting concern about the clash between Iran and the West and the possibility of U.S. military intervention in Iran also weighed heavily on the greenback.

After reaching a seven month low against the euro and the pound, the dollar is slowly limping up. The dollar had suffered a setback with the IMF commenting on the record U.S. trade deficit and the urgent need to correct global imbalances by letting the dollar fall.

Another blow came in the form of the Federal Reserve's signal to end a two-year campaign of raising short-term rates. The currency market which is sensitively linked to the Central Bank and the short-term rates naturally reacted dropping the dollar by another 2 percent. Though the damage is not yet over, the dollar is expected to pick up in a slow but steady manner.

According to Sharada Selvanathan, currency strategist at BNP Paribas in Singapore, " Any correction in the dollar is going to be very limited."

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The US dollar regained some strength following buying by Japanese institutional investors. Chuo Mitsui Trust and Banking forex dealer Yasuhisa Ishida said that other reasons for the firming of the dollar were that no surprise developments were expected on China's foreign exchange policy, and the belief that the upcoming G7 summit would refrain from discussing the widening trade imbalance between the US and China. The Chinese President is on a visit to the US currently. Forbes.com reports:

"In addition, although the dollar was sold recently due to fading expectations of continued interest rate hikes in the US given solid economic fundamentals and rising crude oil prices, I think there is the chance that US interest rates may rise beyond 5 pct," Ishida added.