Why the U.S. dollar continues to rise, defying a 2021 consensus trade

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Bringing Factors Together

Traders typically adopt some combination of the methods outlined above to make their buy or sell decisions. The art of trading exists in stacking the odds—in the form of congruence in the three methodologies—in your favor and building an edge. If the probability of being correct is high, the trader will assume the risk of entering the market and managing their hypothesis accordingly.

Dollar Strength Timeline of 2014–2016

In January 2014, the Fed began tapering its quantitative easing (QE) program. The dollar remained in its 2013 trading range of around 80 (indicated by the dollar index, USDX) for the first six months of 2013. Similarly, the euro traded at a six-month average of $1.3129.

In February, the pro-western forces in Ukraine overthrew the government, sowing the seeds of the Ukraine crisis. In March, Russia annexed the Crimean peninsula in Ukraine. In April, it sent forces to support pro-Russian separatists in eastern Ukraine. Also in March, the Fed announced that it would look at raising the fed funds rate sometime in mid-2015.

Announcements of rate changes by the Fed have an effect on the market, where investors react based on how they think the market will move after the change. This is called the announcement effect.

On October 2, the European Central Bank (ECB) announced it would begin its version of QE. In November, the ECB added it would maintain low interest rates. 

In December, the euro’s exchange rate fell to $1.21, as investors feared the Greek debt crisis would force Greece out of the eurozone. This diminishing value led the dollar to strengthen to 89.95 by the end of the year.

2015

In January 2015, the ECB announced it would continue QE in March. On March 9, it started buying bonds, which increased the supply of euros in circulation and decreased the value of the currency. The euro fell to a 12-year low of $1.0524 on March 13. As the euro fell, the dollar rose. The USDX hit a 52-week high of 100.390 on March 13, 2015, rising 25% from its July 11, 2014, low of 80.030. It closed out the year at 98.27.

Throughout 2015, analysts predicted the euro would fall to parity (where the euro and dollar are equal in value). As a result, hedge funds and other forex traders began shorting the euro. These traders and fund managers included Bridgewater Associates, Tudor Investment, Brevan Howard, Moore Capital Management, Caxton Associates, and the Gavea Fund. 

Shorting is an investing/trading tactic where an asset is borrowed by an investor, sold, and then purchased at a lower price by that investor.

Another factor driving the strength of the dollar in 2015 was a slowdown in China’s economy. Potential credit problems scared investors toward the relative safety of the dollar. China directly pegs its yuan to the dollar—as the world’s second-largest economy, the Chinese market, economy, and currency influence the U.S. dollar immensely.

In December, the Federal Open Market Committee raised the fed funds rate to 0.24%.

2016

In February, the Dow fell to 15,660.18 in a reaction to higher Fed interest rates. Investors didn’t like falling oil prices, the devaluation of the yuan, and the turmoil in China's stock market.

What Makes a Currency Weak?

A weak currency is one whose value has declined in comparison to another currency. Weak currencies are those of nations that have poor economic fundamentals or an ineffective government. A weak currency can be derived from high levels of inequality, political instability, and high levels of corruption, public debt, and trade deficits.

Since January 3, 2022

The S&P 500 stock index hit its last new historical high on January 3, 2022.

Since then, as can be seen in the chart, the stock market has moved downwards. The volatility in the foreign exchange market increased, but the value of the dollar remained, roughly constant.

What changed?

Well, two things seemed to have changed.

First, it became obvious that the Fed was, in fact, actually tapering its securities purchases. And, more and more talk evolved in terms of how many increases the Fed might actually make in 2022 in its policy rate of interest.

So, more and more confidence was being placed in the Fed actually doing something about the inflation problem.

But, then, the Russian problem gathered steam. More and more discussion took place about the Russians actually invading Ukraine and what, exactly, would that involve.

So, the Russian situation became the dominant worry of the investment community, with the concern over monetary policy taking second place.

theSkimm

The US dollar has been riding high lately. Meaning your money goes further in other currencies and when you’re buying imported goods. That’s a good thing. But it can also cause trouble for American companies that make big money in other countries — just another reason to keep your portfolio diverse.

Updated April 20 with the most recent US dollar index, Federal Reserve, and inflation news.

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Skimm'd by Casey Bond, Liz Smith, Liz Knueven, Stacy Rapacon, and Elyse Steinhaus

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