First, some background.
The U.S. Dollar Index measures the value of the United States Dollar relative to a basket of foreign currencies. This “basket” includes the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc.
Not all the currencies have the same weight. The weightings of each currency are:
Euro (EUR) 0.576
Japanese Yen (JPY) 0.136
British Pound (GBP) 0.119
Canadian Dollar (CAD) 0.091
Swedish Krona (SEK) 0.042
Swiss Franc (CHF) 0.036
Unlike the various FX pairs that we trade on our platforms, the U.S. Dollar Index is exactly what it says: an index. It does not reflect the spot price of the currency. Rather, it reflects the price of the Index as traded on the ICE (short for InterContinental Exchange) in New York. Therefore, these contracts are subject to rollover four times a year.
Yesterday, August 6th, the U.S. Dollar Index reached its highest level for the last 52 weeks.
With President Trump now in command, there is a direct correlation between the give and take of politics and economics, on one hand, and the twists and turns of the foreign exchange markets, on the other. His latest target has been the so-called “unfair trading practices” of key U.S. trading partners, like Canada and Mexico; however, the actual bulls-eye seems to have been drawn on China. As Trump raises the ante with that land, imposing tariffs on various imported products, they have been doing their best to respond in kind. This has had the effect of bringing down most commodity prices. Trump’s policies affect the prices of virtually every market traded, from crude oil to the degummed soy oil traded on the Indian NCDEX exchange. Some prices, particularly agricultural products, have been knocked down dramatically.
This, together with rising U.S. interest rates, have helped push the Dollar to these high levels.
An Interest-ing Investment
A basic principle in investing is the significance of interest rates. These determine the pace of economic activity by controlling the costs of doing business. As currency traders, we know that – all else being equal – the countries with the highest “real” interest rates will have the strongest currencies. Of course, this does not mean that you should buy the Turkish Lira just because its related interest rate is 18%. Which is why I say, “all else being equal”. That’s a discussion for another day; or if you can’t wait, drop me an e-mail. Nevertheless, we can easily see why a 0.25 increase or decrease in interest rates, particularly if it’s a surprise, can turn markets on their heads.
From 2010 to 2015, the U.S. Federal Funds Rate was effectively zero. It is now at 2%, with the expectation that it will be raised to 2.25 at the September meeting of the Federal Reserve’s Open Markets Committee. Other countries’ interest rates have been going up, too. It is the expectation of changes in their interest rates and the actual changes that effect the relative strength (or weakness) of the U.S. Dollar against other currencies.
President Trump pointed his finger at the Federal Reserve Bank’s Chairman, Jerome Powell, warning that the continued credit squeeze would undermine his efforts to stimulate economic growth. Yet, at the next meeting of the FOMC in September, if the Fed follows through on its guidance to markets from its previous meeting, it is expected to raise the Fed Funds Rate to 2.25.
Here are the key market reports of this week:
The U.S. will release the Producer Price Index on Thursday, August 9. That too should come in unchanged. Likewise, on Thursday, The Bank of New Zealand (RBNZ) meets. It is anticipated that the RBNZ will not make any changes at this meeting. This comes after today’s meeting of the Bank of Australia (RBA), where no changes were made, keeping rate at 1.5%. On Friday, August 10th, the UK will release its Gross Domestic Product, the U.S. will release the Consumer Price Index, and Canada will provide us with their unemployment data.
Where do we go from here?
Fundamentally, the U.S. economy continues to look solid, despite last Friday’s NFP (Non-Farm Payroll) somewhat weaker-than-expected report. Yesterday, Jamie Dimon, Chairman of the Board of JP Morgan Chase stated that the economy can support a 5% interest rate.
The Dollar is the reserve currency of the world. The U.S. remains the most stable nation, from both a political and an economic perspective. This too has been underpinning the value of the Dollar. Technically speaking, the Dollar, in the 9500 area, looks unstoppable.
However, if you are a contrarian, you might say that the dollar is grossly overbought; that at the very least, it is primed for a 200 point “relief rally”; that perhaps the trade war rhetoric has reached a climax. Both Trump and China could soon be realizing that there are no winners in a trade war; and the high stakes poker game could be coming to an end. If indeed this is the case, the potential for a tremendous sell opportunity may be at hand.
As I’ve said previously, “In a trade war, everybody loses and nobody wins.” Of course, as a speculator, you are in a position to take advantage of any market movement. Just make sure your account is well-funded to absorb the short-term fluctuations that may affect your equity.