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The USD has been the worst performing currency this week, having faced a near-perfect storm - buffeted by several factors including improving risk conditions, higher oil prices and a strong rally in emerging markets. But perhaps the most significant issue was evidence of concern about the magnitude of US debt issuance, which led to US stocks, bonds and the currency all falling simultaneously yesterday. The medium-term dollar bearish view has been mainly predicated on this concern, which is the ugly combination the US economy faces of a large fiscal deficit, QE and strong exchange rate. The new reality that policymakers in Washington are facing is that with declining risk aversion, investors are now demanding higher premium for holding the USD and US assets, especially US government bonds.

While remain medium-term USD bears, some are less confident about the near-term outlook for the USD. What is clear is that US government bond yields need to rise significantly to stabilize the USD but it is less clear if the Fed is prepared to accept much higher long-term yields under QE. The Treasury secretary's comment yesterday that his job is to "sustain a strong dollar" is much more forceful than previous references to the currency and likely reflects concern about the risk of a disorderly decline in the USD. The question is: what can they to do to prevent it? After eight years of a benign neglect dollar policy under the Bush administration, we are indeed in un-chartered territory. While this makes the short-term direction of the USD relatively uncertain, what is clearer is volatility is likely to rise until the uncertainty has been resolved.