EC Uh Oh, The Dollar Has Caught A Bid

Anyone who follows Alhambra knows that we keep an eye on the dollar. It is a very important part of our process of identifying the economic environment. A rising dollar, when combined with a falling rate of growth, can be a lethal combination. That was the situation in March and of course during the financial crisis of 2008. So the recent rally is something that has got our attention. For now, though, we don’t see any significant stresses in the system that would produce that kind of liquidity driven event.

The dollar has been in a short term downtrend since the spike and peak in the heart of the COVID panic back in March. The vast majority of that decline was compressed in a roughly 2 1/2 month period starting in mid-May and ending in early August. But that decline has done nothing to change the long term trajectory of the dollar. The trend has been relentlessly higher since 2014 no matter what dollar index you prefer. From July 2014 to the peak on March 23 this year the broad trade weighted dollar index (not the DXY) rose 35.5% while the trade weighted EM dollar index rose 41.5%. More important was the rapid squeeze higher during the onset of the COVID shutdowns. From mid-February to the peak in March the broad dollar index rose 8.5% and the EM index rose 12%.

The spike in the dollar in February and March has largely been reversed with the recent weakness. But as I’ve said over the last few months as we’ve observed this move, the strong dollar environment is still largely intact. The broad dollar index is today at about the same level as the beginning of 2016. It has been both higher and lower during that time but where we are today is about 24% higher than where we were in mid-2014. The EM index is about 30% higher. That is, by anyone’s definition, a strong dollar.

The recent dollar rally is minor in comparison to the spike in March. The broad index is up about 2.5% from the lows while the EM index is up 3%. It has also been a more gradual rise than what we saw in March. This does not appear, at least at present, to be anything more than a correction of the short term trend. The dollar was oversold and the short dollar trade was crowded. A correction was inevitable and I warned about it in the Market Monitor earlier this month:

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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