The world’s reserve currency is the benchmark pricing mechanism for most commodities. Since interest rates are a primary factor for the value of one reserve foreign currency against others, the 500-basis point increase in the U.S. Fed Funds Rate starting in March 2022 lifted the dollar index to the highest level since 2002 in September 2022.
In a May 13 Barchart article, I asked, “Will the dollar index fall below 100, and does it matter?” The index was at the 102.509 level on May 12, when I wrote, “In mid-May, the June dollar index was at the 102.50 level, and the reserve currency’s index continues to go nowhere fast.” One month later, the index made a slightly higher high but remains in a narrow range over the first half of 2023.
Stability- The dollar index’s narrow 2023 range
The dollar index has traded in a five-point range since the end of 2022.
The June dollar index futures chart highlights the bank from 100.42 to 105.490 in 2023. While the index has held above the psychological 100 level, it has not eclipsed the first technical resistance level at the 105.490 level. At 103.645 on June 12, the index was just above its midpoint for this year.
De-dollarization may not impact the index, but it has significant ramifications for the dollar’s role
Since the dollar index only measures the U.S. currency against a handful of reserve foreign exchange instruments, including the euro, pound, yen, Canadian dollar, Swedish krona, and Swiss franc, it does not reflect the many other world currencies.
The bifurcation of the world’s nuclear powers has increased the demand for a BRICS currency that would include Brazil, Russia, India, China, South Africa, Saudi Arabia, and other significant commodity producers and consumers. Moreover, the BRICS countries dominate the nations in the dollar index regarding population. China and India alone account for more than one-third of the people worldwide.
A departure from global commodity pricing in dollar terms, replacing the U.S. currency with a BRICS foreign exchange instrument, would lower the U.S. dollar profile in the global financial system. With China spearheading de-dollarization and nipping at the U.S.’s heels for economic and military leadership, the threat to the dollar goes far beyond financial impacts. Money is power, so losing the dollar’s leadership position would have a far-reaching effect.
Since the dollar index measures the currency against non-BRICS foreign exchange instruments, the direction of the index could become irrelevant.
The interest rate path may not support future gains
Interest rate differentials play a significant role in determining the path of the dollar index. After increasing the Fed Funds Rate from 0.125% in March 2022 to 5.125% in May 2023, the trajectory of rate hikes looks set to slow or stop. At the upcoming June 14 FOMC meeting, the central bank will pause with a hawkish message or increase by 25 basis points with a dovish statement. Meanwhile, the aggressive tightening period is ending, which could prevent the dollar index from breaking higher.
The case supporting a stable to higher dollar index
The following factors support stability or a higher dollar index over the second half of 2023:
- Geopolitical tensions are at the highest level in decades. Rising hostilities could cause a flight-to-quality for market participants. The U.S. dollar has historically been a haven of safety.
- At over 5%, U.S. interest rates are at the highest level in years, enticing governments, monetary authorities, and supranational institutions to hold dollars as reserves.
- The dollar is the world’s most liquid foreign exchange instrument. While governments intervene in the forex market to promote stability, the dollar’s convertibility and liquidity will benefit the U.S. currency.
- Since the dollar index’s main component is the euro, the war on Western Europe’s doorstep and economic and military threats from Russia could weigh on the euro, supporting the dollar index.
- The long-term dollar index trend remains higher, and even a break below the 100 level would not threaten the bullish path of least resistance.
The chart highlights the dollar index’s pattern of higher lows and higher highs since the 2008 71.05 low. The first significant technical support level stands at the early 2021 89.165 low, significantly below the current level.
The case against the dollar for the coming months
While many factors favor a stable to higher dollar index, others suggest a developing bearish fundamental trend:
- China’s plans to replace the U.S. as the world’s leading economy and military force threaten the dollar.
- China is far ahead of the U.S. in rolling out a digital currency. A digital yuan embraces blockchain technology, increasing transaction speed, efficiency, and record keeping.
- The U.S. administration and Congress recently increased the U.S. debt ceiling. With the deficit approaching $32 trillion and rates over 5%, the U.S. national debt will rise by more than $1.6 trillion annually even if spending and revenues balance and do not increase the level. Rising debt does not support a strong currency.
- Domestic political issues, the indictment of the former President, and a highly contentious 2024 election could cause the dollar’s value to decline. Abraham Lincoln once said, “A house divided against itself cannot stand.” Domestic division weakens the dollar on the global financial stage.
The dollar index is stuck in neutral in June 2023, trading between 100 and 105.50. The long-term trend is bullish, and the short-term path of least resistance is bearish. Meanwhile, whichever way the index moves, the dollar’s global role is diminishing. As the great Hall of Fame Yankee catcher and armchair philosopher Yogi Berra once said, “The futures ain’t what it used to be.” The U.S. currency’s dominant days could be in the rearview mirror regardless of the dollar index’s direction.
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.
