Risk Appetite Is up, and the Dollar Is Hurt

Feb 24, 2021 05:52 PM ET
Risk Appetite Is up, and the Dollar Is Hurt
  • According to Federal Reserve Chair Jerome Powell's testimony to Congress on Tuesday, the US Fed is not letting up quantitative easing anytime soon, and the federal funds rate will remain near zero in the short-term. Powell and his team are convinced that the economy is nowhere near maximum employment and that annual inflation is still below target. 
  • Powell’s commitment to the expansionary monetary policy and the possibility of Biden’s government implementing the $1.9 trillion stimulus package are feeding risk appetite in the forex market. The CBOE Volatility Index (or VIX) is at the lowest point over the last year, indicating waning market fear.

The dollar is slipping across the board

Jerome Powell will appear for the second day straight before the Congress on Wednesday. On Tuesday, the bulk of the testimony touched on the ongoing loose monetary policy. Powell responded to concerns about high inflation risks by assuring US Senate Banking Committee members that the institution’s monetary policy is still the safest bet given the underlying conditions. He said he expects the economy to return to pre-pandemic levels of output "in a few years."

But some investors disagree with Powell, and they have a conviction that continuing low benchmark interest rates and the $120 billion per month bond-buying program is setting the stage for uncontrollable inflation. And these investors are ditching the greenback. 

Nonetheless, it seems currency traders are pricing in other factors such as the possibility of a recovery in the global economy, as shown by the performance of the US dollar against commodity currencies such as the Kiwi. Early morning trades in Asia saw the US dollar index (DXY) edged down 0.09% (0.03% at the time of writing), while the USD/NZD dropped by 0.43% to 1.3556. 

US Dollar Index (DXY), Source: TradingView

Figure 1: US Dollar Index (DXY), Source: TradingView

USDNZD chart, Source: TradingView

Figure 2: USDNZD chart, Source: TradingView

You will be forgiven to imagine that only commodity currencies are edging up against the US dollar. Contrarily, traders are betting on many other currencies that stand to gain from increased global trade. For instance, the USD/JPY was down 0.01% at 13:00 GMT. At the same time, the USD/CNY extended the over six-month decline bringing the overall performance to -6.62% since August 2020.

The USD’s behavior signifies oncoming trouble in the market

Right now, most economies across the globe have managed to cushion themselves from the effects of COVID-19. Many central bankers followed in the Fed's steps and cut interest rates and purchased massive bond amounts. Interestingly, the market appears to have reacted more sharply to the Fed’s monetary policy actions in Q1 2020 than any other currency.

Before COVID-19 became a global pandemic, the US dollar index was edging up towards historical peaks. The index was at 103.0 as of March 16, 2020, but descended into a downward spin to find support. 

The greenback’s performance for the last week indicates a lack of strength to break the downward spiral. As the figure below shows, the DXY looks unlikely to break above the 0.236 Fibonacci level due to lack of strength, as confirmed by the RSI (39.47). 

US dollar currency index (DXY)

Figure 3: US dollar currency index (DXY)

The US dollar needs a significant development if it were to recoup the losses suffered against major rivals, but this does not seem to be happening anytime soon. One major reason behind this reasoning is that the greenback is losing its appeal in the market. 

Many central bankers – as already mentioned – loosened their monetary policies to help their economies cope with the COVID-19 shock. The US Fed’s actions were more drastic, hence the significant decline of the USD since March 2020. But as Powell testified on Tuesday, the Fed is not considering tightening monetary policy in the foreseeable future. So, what happens when other central bankers tighten their monetary policies? It seems the US dollar index has more room to slip further down.

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