Co-written by Mr. Laurence Yang and Laurence Holdings Group's research team in Switzerland.
The US dollar has recently gained ground against virtually all other major currencies, with the US Dollar Index (USDX) trading at the highest level in 15 months and the EUR/USD keeps on falling. Highest inflation in 30 years and economic risks like supply-chain disruptions and shortage of raw materials have only lent support to "safe-haven currencies" like the greenback.
The Fed vs. The ECB
The EUR is, by far, the largest component of the US Dollar Index, making up 57.6% of the basket. The EUR/USD has been in a free fall, slicing through the key support level at 1.15. In the US, tight labor markets and 30-year-high inflation have prompted market participants to bet on faster-than-expected tapering and rate hiking cycle by the Fed. On the other hand, the European Central Bank (ECB) is yet to signal any clear departure from its pandemic era ultra-loose, ultra-accommodative monetary policy.
Meanwhile, chances are, the the divergence between the largest two central banks in the world will not change in the near-term future, offering considerable support to the greenback.
Short-term economic risk beneficial to the USD
With supply-chain disruptions and shortage of raw materials, economic risks are becoming increasingly noticeable. While the equity market is still at the high, with the S&P 500 and NASDAQ up 20-30% year-to-date, the bond market, on the other hand, is sending investors a warning signal: the flattening yield curve, with the spread between the 2s and 30s at the narrowest since March 2020. A flat yield curve can be considered a psychological marker, one that could mean investors are losing faith in a long-term market's growth potential.
As a defensive "safe-haven" currency, the greenback tends to benefit in the current environment - heightened uncertainty and economic risk.
USD longer-term remains bearish
Despite all the tailwinds for the USD we mentioned above, the currency faces more headwinds ahead.
Firstly, the abovementioned economic risks remain short-term, with the worst is over for global supply chain, while the cost of raw materials have also come down significantly, with iron ore and coal prices dropping 50-60% off the all-time/multi-decade highs made in May. If history is any guide, when short-term uncertainties abate and normalcy returns to the global economy, the USD will be the loser - regardless of the Fed's interest rate tactics. That leads us to the next point.
Secondly, if we look back in history, between 2004 and 2007, the Fed aggressively raised its benchmark interest rate from 1% to 5.25%, meanwhile, during the same period, the EUR/USD rallied to the record highs (USD plunged to record lows against the EUR).
Last but not least, the long-term technical charts of the USD are showing the turning point of the greenback (to resume the downside) could be just around the corner.
Below is the weekly candlestick chart of the DX (USD Index Futures). In summer of 2020, the index clearly broke below the 9-year ascending trendline from 2011, went back to retest the trendline in November 2020 due to US presidential election uncertainty - got rejected and collapsed to the downside.
We can see right now in November 2021, the index is seating right at the trendline - which should offer some resistance for the USD rally to take a breather.
At the same time, in August 2020, the EUR/USD also broke above the 12-year descending trendline from 2008 peak. Very similar to the dollar index, the Euro has dropped sharply against the USD during the 2H of 2021 to re-test the broken trendline, which should offer tremendous support as a "floor" (at least short-term) to the Euro.
Conclusion
At Laurence Holdings Group, we do not expect the strength in the USD to last for too much longer:
Fundamentally, when short-term economic risks and uncertainties abate and normalcy returns to the global economy, the USD will be the loser - regardless of the Fed's interest rate tactics.
Technically, the long-term charts of USD Index and EUR/USD are both calling for the rally in the USD to take a halt.
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