Worst month in a decade for the dollar

August; a typically choppy month in forex markets will follow the worst monthly decline for the US dollar in over 10 years. Will the buck’s rebound in the last two days continue?

With a drop of nearly 5% in July, the dollar index just had its worth month since 2010.
Chart: Dollar Index monthly change (10-years)

dollar index monthly change

Source: Financial Times (July 31, 2020)

 

What happened?

So why has the US dollar been having such a hard time of it? There are some short term- and some longer term explanations.
1. Ultra-ultra-loose Fed policy. The Fed’s new programs involve printing new dollars or offering swaps to stop those who need dollars from buying them in open markets
2. Stock markets are at multi-month highs. When investors are feeling greedy not fearful, there is little need for liquidity via the dollar
3. The euro is doing better. The EU recovery fund has created optimism around the euro, which is heavily weighted at 58% of the dollar index.
4. The coronavirus. Whether its mismanagement or a natural result of being the largest developed country in the world, the US is getting hit much harder by the pandemic.
5. Negative real yields. Fed policies mean US Treasuries are now yielding less than inflation, making them less attractive relative to other global government debt.
6. Reserve Currency questions. The US national debt is exploding higher with each new multi-trillion stimulus effort.

 

What Next?

They say don’t fight the Fed- and until the pandemic subsides, the Federal Reserve has promised it will maintain or add to the existing policies, which are creating the US dollar weakness. However things have gotten over-extended, and a short-squeeze could be playing out.


COT Data - Dollar Index (10-years)
dollar index chart
(Source: Zero Hedge August 3, 2020)


Speculators are very net short, and this extreme positioning can quickly reverse.


Chart: EUR/USD (Monthly Candlesticks)
eur/usd chart monthly candlesticks
On a technical basis, this down-sloping 12-year-old trendline could cap the near-term upside in the EUR/USD - i.e. support a dollar rebound.

 

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