The US dollar is being crushed – here’s why you can thank the Fed

The US dollar fell sharply against major currencies on Thursday, with bears assuming the Federal Reserve’s assurance that it will not wind down its bond purchases anytime soon as a green light to sell the currency.

“The last blow to the dollar came from the Fed, which pledged not to touch the policy even if the outlook for the US economy improves as it now expects,” said Joe Manimbo, senior analyst at Western Union Business Solutions.

The weakness also reflected rising expectations that Washington lawmakers will finally agree on an economic bailout package deemed necessary to support a weak recovery, he said.

The ICE US Dollar Index DXY,
-0.77%,
which measures the currency against a basket of six major rivals, fell 0.8% to 89,744 and traded below 90 for the first time since April 2018. It’s down 6.9% so far this year.

In addition, the index has fallen nearly 13% since March, when it peaked to a high in more than three years when the COVID-19 pandemic plunged the U.S. economy into recession and triggered a wave of chaos in financial markets. global investors. in the safety of the world’s reserve currency.

The dollar sell-off on Thursday was broad:

  • The euro EURUSD, the most heavily weighted component of the DXY, rose 0.6% to $ 1.2270, reaching its highest level against the dollar since April 2018. For the year to date, the shared currency is more than 9% up.

  • The dollar fell to a more than three-year low against the Japanese currency USD / JPY,
    -0.36%,
    decreased 0.4% to ¥ 103.07.

  • The British pound GBPUSD,
    + 0.67%
    was up 0.8% to $ 1.3617, the highest level since April 2018.

  • Currencies that typically rise in line with stocks, commodities and other assets considered risky did just that, with the Australian dollar AUDUSD,
    + 0.66%
    and the New Zealand dollar NZDUSD,
    + 0.55%
    each increased 0.6% over their US counterpart. The dollar was down 0.1% against the Canadian dollar USDCAD,
    -0.14%.

US stocks rallied higher Thursday, with the S&P 500 SPX,
+ 0.50%
and Nasdaq Composite COMP,
+ 0.61%
hitting intraday trading records, while the Dow Jones Industrial Average DJIA,
+ 0.42%
increased by about 130 points, or 0.5%.

A falling dollar is generally seen as positive for US and global equities, as well as the global economy. It is also seen as the potential missing ingredient for a bullish turnaround in dollar-priced commodities.

See: How a weaker dollar could fuel a commodity boom in 2021

The Fed assured investors on Wednesday at its last 2020 policy meeting that the central bank would maintain its flexible monetary policy stance, including its bond-buying program, until the economy shows “substantial progress” to recover from the damage caused by the virus. .

Fed Chairman Jerome Powell indicated during his press conference that the central bank would not rush to unwind its monetary stimulus, even though the central bank’s economic forecasts seemed somewhat more optimistic than previous iterations.

The FOMC dotted line looked aggressive … Mr. Powell’s comments were anything but, ”wrote Kit Juckes, global macro strategist at Société Générale, referring to individual interest rate forecasts made by members of the policy-making Federal Open Market Committee.

Of course, other central banks are also taking extraordinary measures to support their economies. And while a weaker dollar is generally viewed as positive for the US and the global economy, it has been a source of consternation for some rivals, including the European Central Bank.

Also read: How the strong euro is hampering the ECB’s attempts to boost inflation in the eurozone

But a big part of the story is about interest rates – especially the difference between bond yields in the US and elsewhere. While Treasurys continue to outperform, say, German government debt, that gap has narrowed, diminishing the incentive to hold US paper and weakening a source of support for the dollar.

The spread between US TMUBMUSD02Y,
0.137%
and German two-year yields TMBMKDE-02Y,
-0.723%
has fallen from 215 basis points, or 2.15 percentage points, to about 90 basis points this year, said Mark Haefele, chief investment officer of UBS Global Wealth Management.

The dollar’s weakness “also reflects the improved outlook for more pro-cyclical currencies amid recent positive vaccine news and a corresponding decline in demand for safe-haven assets,” he said in a note on Thursday, referring to the dollar’s tendency. to find support during periods. of unrest.

“Meanwhile, the prospect of further US fiscal stimulus, with Congress continuing to debate the details of a $ 900 billion COVID-19 bill, is likely to keep an eye on US debt, adding pressure to the dollar” , said Haefele.

Read: Incentive talks about coronavirus will slide over Washington weekend as hurdles still remain

Add to that better prospects for a trade deal between the European Union and the UK, a compromise last week that paved the way for a $ 2.2 trillion EU recovery fund, and the ongoing rollout of COVID-19 vaccines and the stage is for the dollar to keep falling, Juckes wrote.

“The only problem is it is falling too fast,” he said, noting that SocGen in its fourth-quarter euro forecast placed the shared currency at $ 1.27, about 4% above current levels. The euro has gained about 3% in the past month alone.

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