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Is This The Start of a Strong Dollar Cycle

Now that Trump’s presidency is over, the world moves on, having great expectations for the period ahead. On the one hand, the prospects of effective vaccines against the COVID-19 virus suggest that the pandemic’s end nears. On the other hand, the new administration in Washington is supposed to reverse many of the changes in foreign and domestic policies the Trump administration made. 

If there is one thing to attribute to Trump, that is peace. During Trump’s mandate, America was not involved in any major conflict whatsoever, as protectionism and isolationism was applied not only on the economy, but on the foreign policy too.

This already changed and will likely change some more in the months ahead. What implications would a new foreign policy have on the U.S. dollar?

 

DXY Tends To Rise After Inaugurations

As Nordea, one of the largest European investment houses, points in one of its recent research papers, the Dollar Index (DXY) tends to rise after the inauguration of a new president. For sure, 2020 was a year like no other in the sense that the macroeconomic decisions on both monetary and fiscal space have distorted the markets.

However, if we look back at history, Nordea’s research does make sense. On average, the DXY gained after the inauguration day, and the EURUS is the biggest component of the index (i.e., over 40%). Therefore, if history tells us anything, it says that we should expect  lower EURUSD in the months ahead. Can this be the start of a strong dollar story for the rest of the year?

If that is the case, then most market participants will be wrongfooted. The consensus is that the dollar will continue to decline and that the stock market will continue to rise. This so-called reflationary trade makes sense only if real rates in the United States do not rise.

A week ago, after the first NFP report in the United States, the markets offered a picture of what a strong dollar might trigger. Oil, gold, and metal prices fell, the dollar went belly-up, and the real rates too.

What if, instead of investors further bidding for the reflation trade, to actually take-profit on the reflation trade? If new positioning follows in the same direction, as suggested by the historical DXY data, the risk is that the dollar will trigger some major stops on its way higher.

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