By Raul de Frutos
The U.S. dollar fell sharply last Wednesday against a basket of currencies as the Federal Reserve announced a rate increase of a quarter point.
US Dollar index: Source @stockcharts.com.
The move seems to contradict common economic wisdom. In theory, higher raters in the U.S. should make the dollar more attractive for yield-seeking investors when interest rates are lower around the globe. Then, what caused the currency to weaken?
All About Expectations
A rate increase came as no surprise to U.S. markets. The real surprise came in the language that wrapped the announcement. Fed officials intend to keep raising rates; however, they want to keep the economy from getting too hot… but also not too cold.
Investors were probably betting on an acceleration in the path of raising interest rates, not a warming down.
It's Not Only the US Economy That's Growing
Markit Eurozone Manufacturing PMI. Source: tradingeconomics.com.
Another factor working against the dollar is that the U.S. is no longer the sole bright spot in the global economy. Sure, the economic landscape has improved enough for the Fed to start normalizing rates. But the Eurozone - despite a year of political uncertainty - is now growing faster than the U.S. The Eurozone Manufacturing PMI came in at 55.4 in February. The reading pointed to the strongest expansion in factory activity since April of 2011. In China, The Caixin Manufacturing PMI rose to 51.7 in February, the eighth straight month of growth.
Economic improvements abroad could cause the rest of the world to start to catch up to the U.S. in terms of tapering and hiking rates. As a result, the dollar could lose its luster.
What To Watch
President Donald Trump has expressed several times his desire for a weaker dollar. That's a factor to go against the dollar. However, we still need to monitor the situation until Trump provides more clarity on his proposals.
On the other hand, one thing that favors a stronger dollar is a potential change to U.S. tax policy, especially any that provides incentives for companies to bring the cash they have stashed abroad back into the U.S. If North American companies repatriate those earnings, the resulting flow of money could boost the dollar.
What This Means For Metal Buyers
DBB industrial metals ETF. Source: @stockcharts.com.
A weaker dollar on Wednesday contributed to a rebound in industrial metal prices. A falling dollar is bullish for dollar-denominated commodities like industrial metals. Metals are in a rising trend, showing no signs of weakness yet.