HomeHas the Dollar Index Already Bottomed?

Has the Dollar Index Already Bottomed?

As a result of the 2020 COVID-19 pandemic, the world’s central banks and governments reacted swiftly and delivered huge monetary, respectively fiscal stimulus. Financial markets were literally flooded with cheap money, as interest rates were slashed to zero instantly. 

The U.S. dollar declined in 2020 as a result of extreme easing from the Fed. A weaker dollar led to higher equities, which, in turn, supported the optimism in the eventual recovery.

The demise of the dollar triggered fears of inflation. Many reputable voices in the investment community called for caution and warned investors of the imminent dollar debasing. Yet, if one checks the facts, the dollar’s share in international foreign reserves increased, not decreased, during the pandemic. Hence, its role as the dominant world reserve currency strengthened.

One of the most interesting technical analysis theories uses market cycles to discover tops or bottoms – general market reversal. A close look at the last two decades and how the Dollar Index (DXY) performed tells us that there is a thirty-nine-month cycle that corresponds to a marginal bottom in the DXY.

Rising Yields Help a Stronger Currency

The bounce in the DXY is even more interesting if one looks at its weights – the biggest share belongs to the EUR, with about half of the weight, and then the rest is split between the JPY, GBP, CAD, SEK, and the CHF.

2021 started with a surprising rise in the U.S. 10-year Treasury yields. Even more surprisingly, the Fed did nothing to intervene and let the market do its thing. The Fed’s move comes in sharp contrast to what the Reserve Bank of Australia (RBA) did – when it saw the yields rising, the RBA intervened drastically and pushed them back close to zero.

Rising yields reflect optimism about the economic recovery. Depressing them artificially will only force the market participants to look to other areas for yields.

A quick analysis of historical long-term rates in the United States reveals the fact that we are at historical lows. The chart above stopped at 2012, but we all know what followed – after 2012 and the QE2, the Fed raised the short-term interest rates only to slash them to zero and restart bond-buying once the pandemic came. As a consequence, the long-term real rates fell even more.

Therefore, the current rise in the yields is nothing when compared to historical rates. Yet, for some reason, even this timid rise that helped the DXY bounce lately, sends fears of unwanted tightening in both the United States and other jurisdictions.

The rest of 2021 will definitely be interesting to watch when it comes to the U.S. real rates and the DXY. It appears investors forgot that the yields can rise much higher than they are now.

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