The DXY & A Slowing Global Economy

Understanding the role of the Dollar and the US economy through the global lens will help you trade it during uncertain economic environments.
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The DXY and a slowing global economy
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An experienced currency analyst that specialises in short term sentiment and news driven trading.
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Understanding the DXY And Its Impact On The Global Economy

Just quickly following up on a question from Hiroshi, who asks us about the US dollar, asking what would likely happen to the US dollar if the US economy doesn’t recover as fast as expected, and unemployment remains very high for longer?

So great question Hiroshi, and one that we can unpack a little bit more detail. So whenever we look at the US dollar, we need to first understand its role from a global perspective, right?


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So it’s the world’s reserve currency, over 40% of the world’s data’s dollar denominated over 60% of all FX reserves is sitting in dollars. So whenever we have a global slowdown and limitations on international trade from slowdowns, or maybe global pandemics for example, we always see demand for the US dollar, because we have companies and governments and investors all scrambling to get dollars to service data and perform regular operational functions.

So apart from the US economy, we always need to first consider what is going on in the rest of the world. So if the world is slowing but the US economy is slowing slower, then than the rest of the world, then of course, that’s going to be a good environment for the US dollar. So before looking at the US itself, we need to consider it through the lens of the rest of the world. So if we start to see the rest of the world coming out of this recovery faster than the US dollar, or than the US rather, then obviously that’ll start to weigh on the US dollar.

Now, when considering something like international trade, we’ll also need to consider the Feds recent actions in line with that. So the Fed has tried to flood the market with as many dollars as they can, by opening up additional swap lines of countries starting unlimited QE, all with the aim of providing enough dollar liquidity.

Now a lot of that was caused by obviously restricted international trade from the pandemic. So once international trade starts to pick up, that should see some pressure on the US dollar unless the Fed starts to then scale back on some of those measures they’ve put in place. So that’s a very important thing we need to watch. The more dollars become freely available, obviously, the less demand they’ll be and that can see some lower exchange rate for the dollar.

So international trade in line with what the Fed does will be an important consideration. And then if we turn to the US economy itself, there’s a couple of things we can look to and keep in mind.

Now if we just quickly take a look at this Excel spreadsheet, this is basically just a plain economic tracker for the US economy that is divided into all of the major segments of the economy, and tries to track it on a rolling basis. Now, the interesting thing that you’ll notice here is that the dollar is this one over here, the dollar index has become greener and greener and greener as the entire economy has become more red across the board, right?

Now, the reason for that is because the US dollar usually appreciates in an environment where both inflation and growth is slowing at the same time. So as the economy turns down, investors will start to rotate into things like cash, but again, if you look at something like bond yields, for example, bond yields have been starting to move lower across the board in the anticipation of lower interest rates for a while now.

Now normally, that should be negative for something like the US dollar, but we still saw the dollar climb, and the reason for that was because the rest of the world was slowing way before the US economy was starting to slow. So the downturn in the US we can see ended at the end of 2018, here we can clearly see just by looking at red and green, where the economy started to show signs of stress. And even though it was starting to slow from the end of 2018, the rest of the world started to slow way before that.

So they started to slow at the end of 2017, and the beginning of 2018. So even though the US economy was slowing, it was slowing slower than the rest of the world, so to speak. So that was basically a choice between a bad currency and a worse currency in terms of the US dollar strength. So to your question, what will happen to the dollar, if the economy recovers? Recovery takes longer and we see unemployment, you know, stay bad for longer.

Now as long as the rest of the world stays low as well, the US dollar should actually gain from worse than expected data or the worse the data gets, right? So if we see a faster recovery outside the US, then the US dollar is in for some downside. Now the one area that will be very important for the overall health of the US and where the market will think, what the market will think about growth and inflation going forward will of course be the labor market, which is your question as well.

So right now, there are lots of expectations. Let me just quickly turn that squawk down. So right now, there’s lots of expectations, that a lot of the bad data has already been priced in for the labor market, and a lot of the lost jobs will come back once the lockdowns are ease.

Now that is one of the reasons why we’ve seen that downtrend in the jobless claims get a lot of attention because the market is obviously forward-looking in nature. But when you can base something like the slowing jobless claims numbers to something like the continued claims, and you can see that it’s actually showing you a different story, so yes, the amount of new jobless claims has been coming down, as expected, but the amount of continued jobless claims are rising with the latest data still currently sitting at 23 million.

So unless this number starts to slow drastically, it’ll have far reaching negative effects still on the US economy to come. So no work means no pay, no pay means no paying of bills, no spending the economy, no buying of houses. And that is why in line of employment data it’s also gonna be very important going forward to look at something like the housing market, right? So the housing market hasn’t shown as bad science as the rest of the economy, but transmission effects still have ripple effects into other places of the economy like the housing market. So that’ll be another important factor for us to watch.

Now, the effect that all of this will have on the US dollar, again, will depend on how the economy is doing compared to the rest of the world. Firstly, that’s always gonna be the first one.

Secondly, whether the Fed keeps up With those liquidity injections, especially after the demand for dollar starts to go down. And then thirdly, whether the economy can recover meaningfully, or whether it will be more of a protracted recovery like you see it.

So the US is still the biggest and most important economy in the world. So if they struggle to recover, that should also be put some pressure on the rest of the world in terms of recovery as well.

So it will be important for us to not only gauge it from the US economy perspective, but also from the global perspective.

So when it comes to the upcoming US economic data points as long as the dollar is acting and trading like a safe haven, expect the worsening data to be more supportive for the US dollar, and alongside this, also expect that to be more supportive of things like gold and US treasuries, and expect the recovering data to pressure the US dollar alongside again, things like gold and US treasuries. So Hiroshi, I hope that helps, any other questions, don’t hesitate to let us know.


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