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The US Dollar Index isn’t a currency pair. Rather, it is an index which shows how the dollar is behaving against a basket of currencies. It is heavily weighted towards the euro and it often comes in for criticism when analysts consider the constituents which are:

Currency Weighting
Euro 57.69%
Japanese yen 13.6%
British pound 11.9%
Canadian dollar 9.1%
Swedish krona 4.2%
Swiss franc 3.6%


The Dollar Index came into being in March 1973 and many of the original currencies included were ultimately subsumed by the euro in 1999. But these days many analysts argue against the inclusion of the Swedish krona and Swiss franc. Instead they are in favour of including the currencies of China and South Korea (even though the Chinese yuan doesn’t trade freely), or maybe Australia, Brazil and/or Mexico as all seem better representatives of world trade. Certainly, the Asia Pacific and South American regions are under-represented. In addition, aside from the Canadian dollar there isn’t a currency there which typically rises or falls along with commodity prices. Yet despite all this, the Dollar Index is widely followed and can offer a useful snapshot to show overall strength or weakness in the greenback.

Here’s a chart from Bloomberg which shows how the Dollar Index has fared over the last five years. The most important takeaway at the moment is that the basket is currently butting up against resistance around 100. This has marked the top of a trading range which has held since the spring of 2015. The thinking goes that the Trump presidency will be good for the greenback. This is because Mr Trump’s election promises included tax cuts and infrastructure spending programmes which would, if enacted, be highly inflationary. This in turn could lead the US Federal Reserve to resume its tightening of monetary policy which, when combined with loose monetary policies from central banks in other developed countries, should favour the US dollar. Certainly, members of the Fed have sounded hawkish ever since they held back from hiking rates back in September. It’s undoubtedly the case that the market is pricing in a rate rise next month. The CME’s FedWatch Tool (which uses the fed funds futures market to estimate the likelihood of a rate hike at any particular meeting) now assigns a 90.6% chance of a move in December. Of course we’ve been here before. Just over a year ago the Fed raised rates (by just 25 basis points) for the first time since June 2006. They followed this up with a collective “Dot Plot” projection which forecast a further 100 basis points of tightening in 2016. They then rowed back from this throughout the year, initially hinting at a hike each quarter, then failing to follow through.

Now it seems fairly likely that the Fed, just like the majority of analysts and pundits, was expecting Hillary Clinton to clinch the presidency. That would have ensured the continuation of the status quo and would have made it easy enough to slip through a small rate hike before the year-end, despite there still being question marks over the strength of the US economy. Now things have changed dramatically. Now an establishment outsider (or at least a maverick) will soon be taking up residence in the White House. Could this be enough for the Fed to hold off from raising rates once again? We shall see. But there’s now just one month until the Fed’s key meeting which means FOMC members only have three weeks to manage market expectations. If there’s any hint from committee members that a rate hike is in doubt, or if we see another weak Non-Farm Payroll number in early December, then expect the Dollar Index to pull back sharply as investors rush to reposition themselves after being wrong-footed yet again.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Category: PM Bulletin


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