Home > A Bullish Case for the U.S. Dollar

A Bullish Case for the U.S. Dollar

One of the most striking news made headlines at the end of last week – all investment houses around the world see a weaker dollar in 2021. Not even one house disagrees, which makes it a dangerous positioning as the market typically does not like consensus. 

The case for a weak dollar looks very compelling. Millions of reasons exist to sell the dollar, from the Fed printing money to the stimulus checks sent to the American households.

However, one should not forget that the dollar remains the pillar of the current financial system. Is it possible for the world’s reserve currency to strengthen, despite such bearish calls?

ISM Hinting at a Stronger Dollar

If history tells us anything, it suggests that the dollar may strengthen. We saw the ISM manufacturing and non-manufacturing reports very strong when compared to similar reports in other parts of the world. For example, the PMIs in Europe struggle to hold to the 50 level or are well below, in the United States the manufacturing PMI is above 60 and the services one is around 57.

Three out of the last five times when the ISM manufacturing reached 60 or above, the dollar strengthened in the next one hundred days. Could this be the start of a bullish dollar trend?

Typically, a currency reflects the strength of its economy. A normal reaction is to decline on negative economic data and strengthen positive data. Only that the USD is not any currency, but the world’s reserve currency. Effectively, it means that most debt in the world is issued in dollars, so the dollar’s volatility does not depend on economic data only.

So far, the dollar and the financial markets moved in tandem – higher stocks and a lower dollar. This created a so-called risk-on environment where the correlation between financial assets reaches extreme levels. This is a dangerous trading environment because it leads to overtrading because traders fail to identify the correlated assets. In the currency market, buying AUDUSD and EURUSD was the same trade, as the correlation between the two increased significantly. In other words, all it mattered was the USD, not the EUR or the AUD.

Moving forward, there are two scenarios that may lead to a higher dollar. One is for the risk-on environment to turn into a risk-off one. Another is for the USD to reflect the strength of the economy.

Out of the two, the first scenario looks more appealing, considering the economic weakness created by the coronavirus pandemic.

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