The Dollar Index Falls Below Critical Technical Support
In late December 2023, in an article on Barchart, I wrote, “The index is at a crossroads in late 2022. In 2023, the dollar index will move higher or lower with the economic and geopolitical landscapes. At 104.010, the index reflects the current uncertainty about the coming year.” The index closed at 103.269 on December 30, 2022, below the technical support level. At below 102 on January 30, the dollar index continues to make lower highs and lower lows, with the next target at the psychological 100 level.
The Invesco DB U.S. Dollar Index Bullish Fund (UUP) moves higher and lower with the dollar index, and its bearish counterpart, UDN, moves contrary to the index.
The technical resistance level became the support
Throughout most of 2021, the dollar index rallied, breaking out to the highest level since 2002 when it surpassed the 103.96 technical resistance level in May.
The long-term chart highlights the move that turned technical resistance into support. In 2022, the index posted an 8.03% gain. However, the close at 103.269 was below support as the index turned lower from the September 114.745 high.
The trajectory of rate hikes will slow in 2023
One of the most influential factors for the value of one reserve currency versus others is the interest rate differential. The dollar index measures the U.S. currency against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc. However, the most significant exposure at 57.6% is against the euro.
Two factors caused the explosive move in the dollar versus the euro in 2022. The war in Ukraine on Europe’s doorstep is the first significant conflict on European soil since WW II and is on Western Europe’s doorstep. Meanwhile, U.S. rates rose far faster than European rates in 2022.
In March 2022, the midpoint of the Fed Funds Rate was 0.125%, and at the end of the year, it rose to 4.375%. The trajectory of U.S. interest rates supported the rising dollar versus the euro currency.
While the U.S. Fed remains committed to tight monetary policy to battle inflation in 2023, the trajectory of rate hikes will be much lower than in 2022. Moreover, the rising odds of a recession could cause the Fed to pause, which has caused the dollar index to retreat and fall below the technical support level.
The dollar’s role in the financial system is a victim of geopolitical tensions
The Chinese/Russian “no-limits” alliance is another factor impacting the U.S. currency. The bifurcation of the world’s nuclear powers directly affects the worldwide financial system. Tensions between Washington, DC, and Moscow/Beijing have led the Russians and Chinese to settle cross-border transactions with non-dollar assets. Since China is the world’s second-leading economy, the impact on the dollar is significant.
Sanctions on Russia led Moscow to declare that 5,000 rubles were exchangeable for one gram of gold in 2022. The deteriorating relations with China decrease Chinese demand for U.S. government bonds and dollars to settle international transactions.
Over the past months, China has negotiated with Saudi Arabia and other nations to settle commercial transactions with non-dollar currencies. The dollar’s role in the global financial system has declined because of the geopolitical landscape.
The U.S. national debt and domestic political divisions could weigh on the dollar index
The tidal wave of central bank liquidity and tsunami of government stimulus during the worldwide pandemic lit an inflationary fuse. Moreover, it increases U.S. national debt, which stands at $31.5 trillion and is rising. With a slim majority in the House of Representatives, the Republican opposition seeks concessions for approving an increase in the U.S. debt ceiling. The administration has said it refuses to negotiate, setting the stage for a debt crisis that could cause a downgrade and potential default.
Even if expenditures and revenues remain even over the coming months and years, the 4.375% rise in the Fed Funds Rate makes funding the debt an over $1.37 trillion annual expense. Further rate hikes will only increase the interest costs. The bottom line is the domestic political division surrounding the debt ceiling, rising funding costs pushing the debt higher, and a decline in foreign U.S. government bond buying is a toxic cocktail for the U.S. dollar’s value.
UUP and UDN are the dollar index ETF products
The most direct route for a risk position in the U.S. dollar index is via the futures and futures options on the Intercontinental Exchange. The UUP and UDN products are ETFs that provide an alternative as they are available to investors and traders in standard stock market accounts:
- At $27.50 per share on January 30, UUP had $1.464 billion in assets under management. The bullish UUP ETF trades an average of over three million shares daily and charges a 0.77% management fee.
- AT $18.79 per share on January 30, UDN had over $103 million in assets under management. The bearish UDN product trades an average of 183,602 shares daily and charges the same 0.77% management fee.
The dollar index fell from 114.745 in September 2022 to its most recent low of 101.265 on January 18, 2023, an 11.75% decline.
Over the same period, UDN rose from $16.75 to $18.88 per share, or 12.72%. UDN did an excellent job tracking the dollar index’s decline.
The trend is always your best friend in markets across all asset classes. In early 2023, the trend in the dollar index is bearish, and the break below the 103.96 support looks likely to lead to a test of the 100 level and could continue to make lower lows over the coming weeks and months.
More Forex News from Barchart
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- Stocks Recover Early Losses as U.S. Inflation Cools
- U.S. Economic Strength Boosts the Dollar
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
Provided Content: Content provided by Barchart. The Globe and Mail was not involved, and material was not reviewed prior to publication.