HomeWhy Is the Dollar Higher When The Market is Short?

Why Is the Dollar Higher When The Market is Short?

One of the main take-aways of last year was that the lower dollar helped the world fighting the COVID-19 pandemic. Indeed, that was the case, especially after the Fed in the United States opened the USD swap lines with other major central banks in the world. 

Toward the end of last year, all major investment banks in the world have forecasted a higher stock market on the back of a lower dollar in 2021. Various arguments have been brought to justify the so-called reflation trade, all valid.

Fast forward one month into the new trading year, and the dollar is higher, not lower. The EURUSD pair struggles to hold 1.20 after trading above 1.2330 at the start of the year. This represents a more than “three big figures” drop in less than a month, as traders like to say.

Fed Was Not So Aggressive as It Appears

The starting point to understanding the higher dollar is the Fed’s balance sheet. While the Fed did expand the balance sheet in 2020 by re-engaging in quantitative easing, other central banks have been more aggressive.

For example, the Swiss National Bank (SNB) runs a balance sheet the size of 140% of its Gross Domestic Product (GDP). The same is the Bank of Japan (BOJ). Even the European Central Bank (ECB) balance sheet expansion reached close to 100% of the Euro area GDP and rising. How about the Fed? The Fed’s balance sheet expansion barely reached close to 60%, explaining, albeit partially, the stronger dollar at the start of the year. In other words, other central bank jurisdictions eased more than the Fed did. Hence, that favors a higher dollar.

Another thing to consider is the new U.S. Treasury Secretary, Janet Yellen. While running the Fed a few years ago, she was hawkish on the dollar’s role in the international financial system.

Just after she took the helm of the Treasury, the market found out this week that the Treasury Department is cutting issuance plans massively in the first quarter of the year. The aim is to reduce the Treasury General Account balances by more than two-thirds. As a side-effect, this will increase the reserves in the banking system and the initial effect should be dovish for the greenback.

However, at a closer look, cutting the issuance, the Fed will not have what to buy to keep expanding the balance sheet at a faster pace than rivals. Hence, the dollar’s appreciation makes sense.

Should we see no change in the recent trends, the danger is that the dollar’s rally will intensify as the market is positioned on the other side.

Sign up to our exclusive newsletter today!

Tailored emails

No SPAM ever!

Alt coin news

Unsub anytime

After signing up, you may also receive occasional special offers from us via email. We will never sell or distribute your data to any third parties. View our privacy policy here.