In my June 12 Barchart article on the dollar index, I highlighted the index’s sideways trading pattern. I wrote, “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.”
I mentioned, “The dollar index has held above the phycological 100 level.” In July 2023, the index broke below the 100 level, falling to its lowest level since April 2022. The Invesco DB U.S. Dollar Index Bearish product (UDN) moves higher as the dollar index declines.
The index falls below 100 - Lots of room on the downside before technical support
After trading at a two-decade high of 114.745 in September 2022, the dollar index has made lower highs and lower lows. After a consolidation above the psychologically critical 100 level, it gave way.
The chart highlights the break below 100 as the bearish trend since September 2022 continues. There is lots of room for the index to fall as the crucial technical support stands at the January 2021 89.165 low.
The latest economic data does not support rate hikes
The dollar index rallied to the September 2022 high as the U.S. central bank aggressively pushed interest rates higher. The short-term Fed Funds Rate rose from zero in March 2022 to over 5%. Meanwhile, quantitative tightening to reduce the Fed’s swollen balance sheet pushed rates higher further along the yield curve.
As interest rate differentials are a significant factor for the value of one reserve currency versus another, the path of U.S. interest rates pushed the dollar higher against the dollar index constituent currencies.
Meanwhile, the consumer and producer price indices have been declining, signaling falling inflationary pressures. While the central bank continues to commit to pushing inflation to the 2% target rate, the aggressive rate hikes are filtering through the economy. The bottom line is the inflation data has lowered the need for further rate hikes at last year’s trajectory. While the Fed may increase the Fed Funds Rate by 25 basis points once or twice, short-term rates are close to a peak in July 2023.
Expectations for a less hawkish monetary approach have caused the dollar index to decline.
Critical technical support remains far below the dollar index’s current level
The long-term chart displays the significance of the dollar index’s early 2021 low.
The bullish long-term trend in the dollar index began in 2008 at 71.05 and remains intact at just below the 100 level. However, a move below 89.165 would negate the bullish path of least resistance in place for a decade and a half.
While interest rate differentials are critical and falling inflation support a continued weakening of the dollar index, a far more significant factor could weaken the index and the dollar’s role as the global reserve currency.
A BRICS currency could make the dollar index a useless metric
The bifurcation of the world’s nuclear powers began with a watershed event in February 2022. When Chinese President Xi and Russian President Putin shook hands on a “no-limits” alliance, it set the stage for Russia’s invasion of Ukraine. Chinese plans for reunification with Taiwan could also be on the horizon. Relations between Washington, DC, and Beijing/Moscow have deteriorated with U.S. and NATO support for Ukraine. Markets reflect the economic and geopolitical landscapes. War, sanctions, retaliation, trade barriers, and other financial and military events distort markets.
The Chinese-Russian alliance has caused the BRICS nations to work towards a gold-backed BRICS currency to challenge the U.S. dollar’s role as the world’s reserve currency. Brazil, India, China, Russia, South Africa, and the other countries employing a BRICS means of exchange represent most of the world’s population and landmass. Meanwhile, the U.S. dollar is a fiat currency, deriving value from the full faith and credit of the U.S. government. De-dollarization via a BRICS non-fiat currency backed with gold bullion could unseat the U.S. currency in global cross-border transactions.
Central banks worldwide validate gold’s role as a means of exchange as they own gold bullion and classify the precious metal as an integral part of foreign currency reserves. Over the past years, central banks have been net buyers of gold, with China and Russia, two leading gold-producing countries, leading the way in building reserves. While IMF statistics report that the U.S. is the world’s leading gold owner, the U.S. dollar has no gold backing. A BRICS currency with gold behind it could attract significant interest, even from U.S. allied countries.
The trend toward de-dollarization has increased over the past year, with China paying for raw materials in Chinese yuan. A BRICS currency could change the world by limiting the dollar’s role as the benchmark currency for cross-border commodity transactions. Therefore, the function of the dollar index may decline, and the index could become a useless indicator.
UDN is a bearish dollar index ETF product
With lots of downside room before a test of the January 2021 low, the medium-term trend in the dollar index remains bearish. The most direct route for a short position in the dollar index is via the ICE futures or futures options contracts. Meanwhile, the Invesco DB U.S. Dollar Index Bearish product (UDN) appreciates as the index declines.
At $19.27 on July 20, UDN had around $73.5 million in assets under management. UDN trades an average of 90,827 shares daily and charges a 0.77% management fee. The dollar index fell 13.53% from 114.745 in January 2021 to its most recent low of 99.22 on July 18.
The chart illustrates UDN’s 16.24% rise from $16.75 to $19.47 per share over the same period. UDN does an excellent job tracking the dollar index on the downside.
The late Yogi Berra, the Hall of Fame Yankee catcher and armchair philosopher, once said, “The future ain’t what it used to be.” The dollar index’s future is cloudy in July 2023 as the path of interest rate hikes is slowing, and the potential of a gold-backed BRICS could derail the U.S. currency’s role in the global financial system. The bottom line is the dollar index could continue to decline.
Even the most aggressive bear markets rarely move in straight lines. Buying UDN on short-term rallies in the dollar index could be the optimal approach to hopping on the bearish trend.
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.
