The dollar may be ready to rise again after months of weak performance.
The dollar tends to perform well when global economic conditions are uncertain, and also when the US economy is doing well. It does less well when the global economy exhibits normalized growth and calmer conditions. On charts, the pattern is referred to as the “Dollar Smile.”
Since hitting a multi-decade high in September 2022 the dollar has been trending lower against most major currencies. Most analysts believe that the dollar is still overvalued on a historical basis and expect it to continue its downward trajectory. However, recent strength and an improving technical picture suggest that the dollar may be ready to rise from current levels.
Reasons for a Stronger Dollar:
- The dollar remains the world’s reserve currency. Despite the well-publicized talk of “de-dollarization," the dollar will continue to be the principal means of global exchange for the foreseeable future. The world's business runs on dollars, and that will provide ongoing demand for the greenback.
- Dollar interest rates are higher than most other currencies. Investors can put their money into high-yield savings accounts at US banks and receive a 5% risk-free return. Many investors who believe global stocks are overpriced have taken advantage of this opportunity as an alternative to equities.
- The US banking crisis appears to be contained. The recent bank failures contributed to the negative sentiment on the dollar, but there has not been evidence of spreading contagion in the industry. The current weakness in the banking sector is based on lowered profit projections rather than being seen as evidence of an existential crisis in the industry.
- Technical reasons: The US dollar has formed a double bottom on the weekly charts, similar to a pattern formed in 2021, which set the stage for a run to multi-decade highs. The charts often show money flows well before the underlying reasons become apparent.?
Why the Dollar Could Weaken this Year:
- The Fed may not continue to raise interest rates.? At the most recent post-FOMC press conference Chair Powell described current policy as “tight,” and adding "We're closer, or maybe even there," when asked about the end-point of the current tightening cycle. Swaps and futures markets are suggesting that the Fed will likely reduce interest rates before the end of the year. Lower interest rates could result in flows out of the dollar.
- The US consumer runs out of spending power. Most of the US economy is dependent on consumer spending, and recent indicators show that consumers are likely to pull back in the coming months. An economic slowdown (or recession) would most likely put pressure on the dollar.
- The trend to “de-dollarization” accelerates. Many countries have expressed interest in replacing the dollar in international trade. There have been examples of countries using non-dollar currencies for crude oil and other commodity transactions. These have been very limited in scale, but have set an example that may grow in size over time.
- Technical reasons. The current bounce in the dollar may be a short-lived correction within a bigger-picture downtrend. This will be confirmed if DXY drops below the recent low of 100.79. That would project a move down to 97-98.
The dollar historically benefits from a strong US economy but it also does well during periods of global economic chaos. Investors are always seeking the best return on capital, but they are primarily focused on the safety of investments. The “exorbitant privilege” enjoyed by the dollar still persists because investors believe that the greenback is the most stable and liquid currency in the world.
How are you preparing for a bearish or bullish dollar?
History tells us that various financial projections can be upended.
Treasurers and internal financial teams should prepare for increased Forex volatility to protect themselves from adverse movement that will affect their P&L.
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