HomeWhy Is the Dollar Stronger When the Fed Is Dovish?

Why Is the Dollar Stronger When the Fed Is Dovish?

The first quarter of the year did not bring anything new from the major central banks. From the Fed to the Reserve Bank of Australia (RBA), the Bank of England (BOE), to the European Central Bank (ECB), all central banks remain accommodative. 

Out of all central banks and their currencies, the Fed’s monetary policy and the U.S. dollar’s reaction are the most important ones. Therefore, the March 2021 decision and the press conference that followed the FOMC Statement were decisive for the dollar’s outlook in the short and medium-term.

A curious thing happened – despite the Fed leaving all the accommodative measures in place, the dollar gained against its rivals. In some cases, the dollar gained more than five-big figures (i.e., five-hundred pips points) as it did against the euro. In some other cases, it rose even more, from 102 to 110 against the Japanese yen.

The big question now is – how much higher will the dollar go? Is this just a pullback after the 2020 meltdown or the start of a new, even stronger trend?

High Beta Currencies Remains Well Anchored

 

As mentioned earlier, the dollar did not appreciate equally across the board. This is only normal, as some currencies proved to be more reluctant to the greenback’s strength.

For example, growth revisions do help the so-called beta currencies (i.e., NOK, CAD, GBP), and thus the exchange rates did not react in a similar way. For instance, the USDCAD is in a stronger bearish trend, down over a thousand pips since the 2020s highs, fueled by a spectacular bull run in the WTI crude oil price. For a pair like the USDCAD to reverse course, more is needed. The same is valid for the USDNOK.

One of the major themes recently was the rise in real rates. Following the U.S. growth upward revisions, the real rates pushed higher, as they do in an economic recovery. As a result, the JPY and the CHF were the casual victims, as shorting the CHF offers a higher carry. In fact, a quick comparison of the U.S. 10-year real rates and the dollar’s performance against the JPY and the CHF shows a direct relationship in place.

All in all, the dollar’s strength has different explanations and is not reflected the same on all currency pairs. Therefore, investors should use other available tools to assess its future strength or weakness.

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