Search

Why is the U.S. Dollar so Important?

Not only is 60% of all foreign bank reserves held in U.S. dollars, but the U.S. dollar is the de facto currency or the reserve currency for the facilitation of global commerce. The trust and good faith in the ability of the U.S. to pay its debts can impact trading and financial markets around the world.


When compared to other currencies, the U.S. dollar has remained stable over the years. The U.S. trade balance continues to fluctuate, especially with China, as the Federal Reserve continues with its easy monetary policies. China wants more control over its economy and with its trading partners. In recent years, China has indicated it wants its currency, the yuan, to replace the U.S. dollar as the global currency in the future.


What are the key factors that drive the U.S. dollar?


1. Like any other fiat currency, the U.S. dollar is based on a relative value. It depends on the economic outlook of the U.S. economy to its trading partners.


2. The U.S. dollar remains the reserve currency for international trade and global financial transactions. There is a strong demand for a reserve currency since it is stable and safe. The high demand for dollars typically leads to a rising U.S. dollar, at least from a longer-term perspective. However, countries like China and the FED's easy monetary policies can erode the high demand for dollars.


3. Besides fundamental and technical factors, market psychology and geopolitical risks can also impact the direction of the dollar's value.


Many currency traders and macro money managers pay close attention to market sentiments and various economic and technical factors, including government data, to gauge when to buy and sell dollars. As technical analysts, we monitor the U.S. Dollar Index (USD) for pivotal turns in the dollars against the other currencies in the index.


Since the start of futures trading in 1985, ICE Futures compiles and maintains the Dollar Index (USD). The index is the value of USD relative to a basket of foreign currencies or a basket of U.S. trading partners' currencies. It is a weighted geometric mean of the dollar's relative value against six (6) foreign currencies – Euro (EUR - 57.6% weight), Japanese Yen (JPY - 13.6%), Pound sterling (GPP - 11.9%), Canadian dollar (CAD - 9.1%), Swedish krona (SEK - 4.2%), and Swiss franc (CHF -3.6%).


U.S. Dollar Index (USD) is nearing a critical junction, at least from a technical perspective. The dollar may breakout and go higher or reverse and go lower. It is approaching a near-to-medium term inflection point. The direction of the USD can impact commodities, bonds, foreign investment flows, and others. In recent weeks, the commodity prices have become increasingly volatile, partly driven by the fluctuations in the dollar, inflation concerns, and the COVID-19 delta variant.


If the USD stalls and begins to retreat, this bodes well for the commodities rally, including many commodities-related stocks (i.e., industrial metals, basic materials, energy). However, if the USD breaks out, this may pressure commodities and lead to additional selling into the summer to early fall.


Enclosed below are the charts of the USD and the historical relationships of the USD against CRB and SPX.



Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com


27 views0 comments

Recent Posts

See All