On April 24, I wrote that the dollar index was going “Nowhere Fast” in a Barchart article. The June dollar index futures contract settled at 101.073 on April 24, when I wrote:
Economic and geopolitical events impact the worldwide currency markets, and the events since early 2022 may be changing the dollar’s role in the global financial system. Therefore, the index is a mirage as it only reflects the dollar’s value against foreign exchange instruments issued by U.S. allies.
In mid-May, the June dollar index was at the 102.500 level, and the reserve currency’s index continues to go nowhere fast.
The 100 level is holding
The downward trajectory of the dollar index has stopped, but the nearby June futures contract has been consolidating above the psychological 100 level.
The chart highlights the decline to 100.420, the most recent low. While the 100 level does not have significant technical significance, it is a milestone for the index that measures the U.S. currency against the other world reserve foreign exchange instruments. The current consolidation began in mid-April when the index stopped short of a challenge of the 100 level.
The index and dollar face a U.S. debt ceiling crisis
On Tuesday, May 9, President Biden sat down with the Senate and House of Representatives leadership to discuss the debt ceiling. Congress has proposed to cutting spending, but the administration has said there can be no negotiations about increasing the ceiling. As the June 1 deadline nears, both sides have begun discussions.
The first default would devastate the U.S. credit rating, pushing bonds and the dollar lower. The odds favor a resolution that kicks the debt can down the road with an increase in the allowable borrowing limit. However, the over $31.7 trillion debt will rise if revenues and spending balance because short-term interest rates at 5.125% imply an over $1.62 trillion annual increase.
The odds favor a resolution for one reason
Any default would cause each U.S. political party to point the blame at the opposition; the current rhetoric validates that Republicans blame Democrats and vice versa. However, the debt has increased under recent administrations from both parties. A default that causes economic and market turmoil will land at the feet of all parties in Washington, DC, making it an untenable option.
While some politicians seem ready to allow the U.S. to default on its debt, a rational understanding of the consequences will likely prevail. However, that does not mean the dispute will not reach a fevered pitch before a last-minute compromise that will probably be a temporary fix for a chronic problem. When the sides finally agree, we could see a relief rally in stocks, bonds, and the dollar. Still, volatility until then is likely as Republicans and Democrats play a financial game of chicken.
Technical support for the dollar index is well below the 100 level
A move below the 100 level will have little technical significance and seems likely as the debt ceiling issue approaches the June 1 line in the sand.
The long-term chart shows the dollar index’s bullish pattern of higher lows and higher highs since it found a bottom at 71.05 in April 2008. The critical level for the decade-and-a-half bullish trend stands at the January 2021 89.165 low, and a move below that level would end the bullish trend. Therefore, the dollar index could have substantial downside price action over the coming weeks.
The dollar could decline on the world stage even if the index rallies
The dollar index could fall precipitously over the debt ceiling issue, but it could also recover when the sides reach a compromise. However, the index remains a mirage as it only measures the U.S. currency against euros, pounds, yen, Canadian dollar, Swedish krona, and Swiss francs.
In an April 24, 2023, article on foreign policy.com, author Joseph W. Sullivan outlined that a BRICS currency would challenge the dollar’s dominance and reserve currency status. The issue is a rising trend of de-dollarization for Brazil, Russia, India, China, and South Africa. Elon Musk believes the dollar’s role in the worldwide financial system is in jeopardy because of sanctions. He recently tweeted, “If you weaponize currency enough times, other countries will stop using it.”
In a May 2, 2023 article, author Vinod Dsouza reported, “A total of 24 countries are interested in accepting and trading with BRICS currency when it launches on the international stage. The group of developing countries is moving to bypass the U.S. dollar to settle global trade.” Leading OPEC members, controlling the international petroleum market, are looking to join forces with the BRICS bloc of nations.
The most direct route for a risk position in the dollar index is via the ICE futures. UUP is a bullish dollar index ETF, and UDN is its bearish counterparty. Meanwhile, since the dollar index only measures the U.S. currency against allied countries, the BRICS currency may not impact the dollar index, and it could rise even though the dollar’s worldwide role declines.
Since BRICS countries are significant commodity producers and represent the developing world, a dollar challenge could cause commodity prices to rise dramatically. Goldman Sachs has forecast a “commodities supercycle” based on “underinvestment” in raw material production. A decline in the U.S. dollar’s dominance on the worldwide financial landscape would only fuel the bullish fire that could rage in the commodities asset class.
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.
