The U.S. dollar had declined significantly against peers in the course of the previous year. When the pandemic gripped the world’s economies, the Fed intervened and opened swap lines with other major central banks in the world.
The result was that the liquidity in the financial system improved drastically, and the investing community’s risk appetite increased. As a consequence, the greenback declined steadily most of 2020.
However, it bottomed right at the turn of the year. No matter how you look at it when measuring the dollar, it recovered significantly since the December lows. What will the Q2 2021 bring for the greenback?
Key Levels Ahead for the Dollar
The chart above shows, without a shadow of a doubt, that the dollar’s strength is reflected by all three main measures – the Dollar Index (DXY), the MSCI Emerging Market Currency Index, and the U.S. Fed Trade Weighted Nominal Broad Dollar Index.
However, divergences existed in the first quarter of the year, and they are worth mentioning here. Why? Because interpreting such divergences is key for traders looking to profit from similar circumstances in the second quarter of the year.
Take the EURUSD, for example – the most important currency pair of the FX dashboard. The pair declined to 1.17 at the end of March, but it is already two hundred pips higher, trading close to the 1.19 level yesterday.
Another place to look for divergences is the U.S. stock market. The main indices continued to rally in the first quarter of the year, despite a stronger dollar. If the dollar’s bullish trend ends and the decline resumes, as suggested by the EURUSD pair, then the stock market indices are poised to make new highs.
One thing is for sure – inflation expectations are rising, and the threat of deflation is behind us. Think of all the fiscal stimulus already in place and the new measures announced to be implemented later this year. Effectively, it means that inflation will continue to rise, as pointed by inflation expectations that already are back above pre-pandemic levels.
Finally, the AUDUSD diverged from the higher dollar theme in Q1 2021. In fact, the AUDUSD reached a new high above 0.80. Therefore, if there is one currency pair that might diverge from the rest in Q2 2021, that is the AUDUSD pair.
All in all, the dollar trades with a mixed tone currently – rising against some rivals, falling against others. Investors will keep an eye on pivotal levels, such as the 1.20 on the EURUSD pair, for further clues on how to trade the dollar in the current quarter.