Inflation is going to be a problem, but not the worst
23 September 2021
Calendar spread on cotton (and some considerations)
29 September 2021
Last week the Fed held a meeting that gave several indications about its future monetary policy. I will not talk about these indications; I have already explained them in this article "Inflation is going to be a problem, but not the worst". Today I will just analyse the US dollar to understand its future trend.
Below, you can see the chart of the Dollar Index (DX).
The Dollar Index, for those who do not know, is an index that measures the strength of the dollar against a basket of other six currencies. Basically, a depreciation of the index indicates a weakening of the greenback. Conversely, a rise in the Dollar Index indicates a strengthening of the US dollar.
The six currencies are:
- Euro: weighting in the index of 57.6%;
- Japanese Yen: weighting in the index of 13.6%;
- British Pound: weighting in the index of 11.9%;
- Canadian dollar: weighting in the index of 9.1%;
- Swedish Krona: weighting in the index of 4.2%;
- Swiss franc: weighting in the index of 3.6%.
This indicator was created in March 1973, when many of the world's major countries allowed their currencies to fluctuate freely against each other. The initial value was set at 100.
A couple of things stand out from the chart. The sharp fall from March 2000 to January 2001 as the Fed injected more liquidity into the markets to counter the Covid-19 crisis. The subsequent lateralisation phase which in recent weeks (exactly since June 2021) has become tighter, between $92 (support) and $93.50 (resistance).
This is due to the fact that at the June Fed meeting for the first time Powell spoke about tapering, which, as we have seen in recent days, is likely to be introduced with the next Fed meeting in early November (2-3 November). Although with Powell anything is possible; he is capable of saying one thing and changing his mind completely the next week.
Tapering is the gradual slowdown of large-scale asset purchases (usually bonds) by a central bank.
The tapering should (I always use the conditional) give a bullish push to the dollar, also by virtue of the fact that, according to what Powell said, it would end by the middle of next year and not, as initially assumed, by the end of 2022 (therefore at twice the speed of what was thought). This aspect should not be underestimated.
A clarification. The tapering that Powell intends to implement only concerns the increase in liquidity injected by the Fed to counter the effects of the pandemic, and does not touch the QE (Quantitative Easing) programme.
The fact that something has changed since June can also be seen from the COT.
In fact, from June to the end of September, the net position of the Speculators went from -453 to just over 25k. So, a large proportion of them has already gone long on the dollar.
Finally, interest rates should not be forgotten. At its September meeting, the Fed for the first time planned to raise rates by 25 basis points as early as 2022. Although this, for all those using Fed Funds Rate futures, was a very likely event several weeks before.
Conclusion. The Fed has assumed the introduction of tapering should take place after the next meeting on 2-3 November (so watch out for next week's employment data). That is if Powell does not change his mind.
At this point we will have to see what the other central banks will do, starting with the ECB. If they continue with their stimuli, as seems likely at the moment, then we will see an appreciation of the dollar with a break of the $93.50 level, which would correspond to a downward break of 1.17 for the Eur-Usd.
On the other hand, if Lagarde announces tapering at the next ECB meeting, we are likely to see a continuation of the lateralisation of the Dollar Index between $92 (or more broadly $90) and $93.50. But at the moment this is the least likely scenario.
Last week the Fed held a meeting that gave several indications about its future monetary policy. Today I will just analyse the US dollar to understand its future trend
I am a macroeconomic and financial analyst with over 30 years’ experience, including two years as a fund manager. I specialise in currencies and commodities, and I am the author of several successful books on trading, macroeconomics, and financial markets.
