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U.S. Dollar Weakness Will Be Short-Lived

Hedge Insider profile picture
Hedge Insider


  • USD has reactively been sold, in the midst of the emerging global pandemic which is the coronavirus.
  • EUR has risen significantly, causing the U.S. dollar index (or DXY) to plunge. This has also continued following a Fed rate cut, not (yet) followed by the ECB.
  • However, USD is likely to be favored once the dust settles. Italy has recently implemented stricter measures which will likely impact their economy significantly.
  • Even if risk-off sentiment continues, USD is likely to find strength as Italy and other European nations, such as France are likely to be hard-hit by the continued coronavirus threat.
  • While the U.S. is not immune, per Dollar Smile Theory, it is likely that USD will remain in favor as a safe haven.

The U.S. dollar is the world's reserve currency. Today, this means that it is the most coveted of all currencies per global central bank reserves (see chart below). While major financial institutions and investors naturally favor USD given that it is highly liquid, many important and popular commodities, such as gold and oil, are also priced in USD.

Central Banking FX Reserves by Major Currency(Source: Bank of International Settlements. BIS data suggests major FX reserves favor USD in the region of 50%, while IMF data indicates that more than 60% of central bank reserves are denominated in USD.)

The recent decline in the value of the U.S. dollar has been rapid and, for many, unexpected. The chart below shows the recent decline in DXY, the U.S. dollar index.

DXY: The U.S. Dollar Has Collapsed(Chart created by the author using TradingView. The same applies to all subsequent candlestick charts presented hereafter.)

It is important to note that DXY heavily weights the euro; and EUR/USD has risen rapidly in recent times (see my recent article for more details). The decline coincides with a fall in U.S. equities, which has been equally surprising, although perhaps not for some; the threat of the coronavirus (the virus being SARS-CoV-2; the disease being COVID-19) has engendered an evidently significant de-risking among global investors.

S&P 500 Futures Draw-downThe chart above illustrates two levels (see the horizontal black lines) which are 10% and 20% from all-time highs. Heuristically, traders consider a 10% draw-down as a correction; a 20% draw-down is considered a bear market. U.S. equities are currently in the middle of this area (having recently hit the midpoint of this crucial area).

Conventionally, when markets are not so volatile, traders would expect to see the U.S. dollar rise in line with falling equities (i.e., not fall together with equities). This is because when the dollar rises, equities appear cheaper in international FX terms. For example, if the euro strengthens (as it

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Hedge Insider profile picture
Providing commentary and analysis, principally focused on global macro, foreign exchange, and equities as an asset class. Primary interests include equity investing from an international perspective, and FX fair values.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Comments (3)

Jeremy Robson profile picture
Sounds about right to me. Thanks for the article.
Why should the dollar be strong? Does the US have a budget surplus, no debt, and a huge sovereign wealth fund?
Hedge Insider profile picture
Why should the euro be strong? Does the eurozone have a budget surplus, no debt and huge sovereign wealth funds?
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