Why Is The US Dollar Falling?
Over the last year, we have seen some significant changes in the financial markets. This fact has extended to all asset classes, with stock market benchmarks like the S&P 500 and Dow Jones Industrials posting extended highs with few retracements. But one asset that has been falling is the US Dollar, and this is something that has caught many in the market by surprise.
Chart: PowerShares DB US Dollar Index Bullish (UUP)
To understand why these events have been happening, there are several factors that should be considered. First is the fact that stock markets are trading near record levels with very little to be seen in the way of bearish declines. This helps make it clear that most investors are not interested in holding cash and that there is positive sentiment that is growing with respect to the US economy and this is something that will continue unfolding well into the first half of this year. In the chart above, we can see the PowerShares DB US Dollar Index Bullish (UUP), which is one of the exchange traded funds used to track the value of the greenback.
Federal Reserve
For many, the conventional wisdom tells us that higher interest rates lead to higher currency values. This is because investors have more incentive to buy the currency using carry trading strategies and this can be important when markets are deciding direction for the current trend. But in the latest scenarios we have started to see falling values in the US Dollar even though the Federal Reserve is one of the few major central banks that is actually in a position to raise interest rates.
So while we did see an interest rate hike from the Federal Reserve relatively recently, markets are looking elsewhere when taking cues. If the Donald Trump administration is successful in negotiating changes in currency policy with China, we could see some major weakness in the US currency.
Policy Changes
The China currency issue will likely get much more attention over the next few months but shorter-term many in the financial markets are likely to look for evidence of policy changes that will come as a result of the next Republican administration. Fed Chair Janet Yellen has already made comments suggesting that the election of Donald Trump as added a significant amount of uncertainty, and this is something that could complicate the issue when we are dealing with the potential for higher interest rates in the US.
But what is becoming clear now is that higher interest rates might not be enough to change the downtrend in the US Dollar. Now that President Trump has taken office, jawboning and rhetoric from central banks around the world could produce shifts in the ways that investors and consumers view the differences between developed economies and emerging economies. We will continue to monitor these trends as they unfold, as the broader world impact could be significant.