Leading Indicator: The Value Of The Dollar

Summary

• The value of the U.S. dollar continues to get stronger as the Federal Reserve continues to lead other central banks in raising its policy rate of interest.
• For the last year, the value of the U.S. dollar has been rising, and, as things currently look, it seems as if the value of the dollar will continue rising.
• Can the value of the dollar continue to rise over the next six months, the next year, or beyond?
• Something is going to have to change.

piranka/E+ via Getty Images

Look at the value of the current value of the U.S. dollar.

Today, it took less than $1.0500 to purchase one euro.

Also, it took less than $1.2500 to purchase one British pound.

It has been a long year for the dollar, but over the past 12 months, the value of the U.S. dollar has been on a constant rise against these two currencies.

The U.S. Dollar Index (DXY) is creeping up to $104.00.

What's going on here?

Well, the Federal Reserve in the United States raising its policy rate of interest faster than is the European Central Bank and the Bank of England.

It's all relative.

And, investors are believing that the Federal Reserve will continue to raise its policy rate of interest faster in the near future than either of these other two banks.

The Federal Open Market Committee of the Federal Reserve System is supposed to meet this week and it is expected that the committee will raise the range for its policy rate of interest by 50 basis points.

That will move the range up to 0.75 percent to 1.00 percent.

Also, this week the Bank of England ("BofE") is meeting, and the expectation is that the BofE will raise interest rates only by 25 basis points.

By the way, this will be the fourth consecutive meeting that the members have raised interest rates.

The European Central Bank is postponing things for a little while longer. The expectation is that the ECB will raise its rates by 25 basis points and not more.

Thus, the Federal Reserve seems to be leading the pack in terms of pushing up interest rates.

And, in looking at the data, it appears as if this relationship between the interest rates of these three central banks have been on this track since last May.

Take a look.

Here is the chart for the past year for the ERU/USD.

The Euro/US Dollar exchange rate (Wall Street Journal)

And, here is the chart for the past year for the GBP/USD.

Great Britain Pound?U.S. Dollar Exchange Rate (Wall Street Journal)

It appears as if in each chart, the price topped out just about 52 weeks ago and has been on a downward trend ever since. So, with all the variability that has been going on in the world, investors seem intent on one particular thing...the value of the U.S. dollar.

Let me just add the chart for the U.S. Dollar Index.

US Dollar Index (Wall Street Journal)

Here we see the almost constant rise in the index over the course of the past 12 months.

Reasons For The Rise

Analysts are generally giving two reasons for the rise.

The first reason is directly connected with the monetary efforts of the Federal Reserve System.

The Fed is tightening up on monetary policy and seems to be somewhat "out of sync" with other central banks in terms of the efforts it is making to produce a more restrictive monetary policy and relatively higher interest rates.

The second reason has to do with where the "risk-averse" money is flowing in the world today.

For quite some time now, the United States has been a "safe haven" for international funds that want to feel secure in where their money is being placed.

The United States has been the primary beneficiary of this flow of money. This has provided a lot of support for the dollar over time.

When the Federal Reserve finally got through to the financial community that it was, in fact, going to tighten up on its monetary policy and then actually began to make moves that supported a tighter monetary stance, the investment community translated this into higher and higher prices for the U.S. dollar.

Now What?

The question now becomes, what is going to come next?

The future, right now, looks to be one in which the U.S. policymakers keep ahead of the policymakers in the Bank of England and the policymakers in the European Central Bank

Federal Reserve officials have been talking about several more rate increases this year, some of them possibly in the range of 50 basis points.

We read in the Financial Times:

"Investors are betting that interest rates--which are currently b between 0.25 percent and 0.50 percent--will be lifted to 2.7 percent by the end of the year."

The Bank of England is expected to raise rates one maybe two times this year and is expected to get nowhere close to the U.S. figure.

The European Central Bank has talked about one interest rate rise this year...possibility two...but this will bring the ECB nowhere near where the Federal Reserve will be.

What might this mean?

The Future

My concern with this picture is that it presents the possibility of a real situation of disequilibrium.

We just cannot look at these central banks in isolation.

It seems as if the Federal Reserve needs to pursue a course similar to the one pictured above.

It seems to me that the Bank of England and the European Central Bank are lagging behind the curve.

And, the situation has been going on for a year now.

Can this situation continue, given the suggestion about the moves these central banks might make this year?

I think that these central banks are going to have to get together and work something out. I don't see how the current direction of the market can last.

But, if the central banks get together, will it be possible for them to come up with a policy that is consistent throughout.

This is a global problem and cannot be resolved just by the individual participants.

Keep your eyes on the foreign exchange market and what these central banks do to manage their currencies so as to maintain peace and stability in the foreign exchange market.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Comments

[Haav Bline]

It is just the privilege of being the king of the jungle. Same script after the 2008 financial crisis. Coordinated manipulations of G7 central banks that push up the dollar and sends global liquidity to support painless, recession-free US recovery first. After that our allies get to share some scraps, and (most of) rest of world gets to hold the bag.

[kmeixner.km]

I am more interested on what happens next to the dollar in a couple of years as inflation and higher rates will very likely cause a recession. As we then reduce rates to zero, the dollar will get crushed. If they calculate inflation the same as the 1980's we would show the true 16% inflation rate. Consumer is pending is 68% of the economy which will result in economic problems. Markets start pricing this in 6 to 12 months in advance. Often it begins with elevated volatility as the market grinds lower. The snapshot right now of the dollar strength which likely continues in the short term is obvious. In a year or so a whole new trend will likely occur.

[josephaoppenheim]

The Fed is doing fine. Employment is also a mandate of the Fed and employment has likely been better, near record low unemployment and record high job openings.

As far as inflation, much is good inflation, like of the wage increases, the highest % increases are with low wage workers, plus, so far, most well run companies have been able to pass on higher costs.

Of the bad inflation, some is transitional, like supply chains, and some is due to the moral fight for freedom in Ukraine. And the Fed has already talked up most rates.

Generally, it’s wise to have a strong dollar. It preserves the reserve currency status of the dollar. As for trade, most well run US multinational companies have operations abroad and can mitigate currency headwinds.

This is the 4th industrial revolution - digitization, and like all such revolutions, some will be hurt with “creative destruction.”

[User 47813974]

@josephaoppenheim

As far as inflation, much is good inflation, like of the wage increases, the highest % increases are with low wage workers, plus, so far, most well run companies have been able to pass on higher costs.

Uh, Ok.

Inflation 40 year high: CPI March 2022 hits 8.5% annually.

[M Plaut]

After Russian assets were seized so quickly and so thoroughly, other countries will be more wary of keeping their savings in the US in dollars. This is certainly true of China, but will also apply to almost everyone to some extent.

[fujilomi]

Well, you can't say the FED is behind the curve so MUST tighten faster, but no no, Must Not tighten faster because the dollar will be too strong. Have to make up your mind.

[sethmcs]

What's next? S&P misses earnings badly due to strong dollar. Market takes next leg lower and recession fears increase.

[Ktennis_00]

Foreign owners of US assets are seeing currency gains, but prospective new buyers will find them increasingly expensive. The US needs foreign buyers of its assets, especially Treasury securities, to finance our current account. Their enthusiasm will be diminished if the dollar continues to rise.

[VictorN]

For the average Joe the strength of the US$ against other currencies is irrelevant. Inflation and income security are the main worries.
Even if one is a world traveler carrying US$, the price of goods and services at the local country is what matters.

[analoguy]

Yes, the value of the dollar keeps going up, sort of! Against the Euro or Yen, yes. But I need more of them to buy almost anything physical I can think of. So, is the dollar really " going up". ? A question of perspective, I guess.

[dougkitchen]

The strong dollar puts more of the inflationary pain on our allies. Another +25% or so might let us avoid a recession. Sometimes the free market is cruel to your best friends, other times there's some left over.

[jlmanfred]

Is the US dollar getting stronger due to other currencies weakening at a faster rate?

[John M. Mason]

@jlmanfred yes!

[OverTheHorizon]

@jlmanfred higher interest rates