The dollar index measures the US currency against other world reserve currencies. While the index includes the Euro, British Pound, Japanese Yen, Canadian Dollar, Swedish Krona and Swiss Franc, the movements of the Euro against the US Dollar exchange rate dominate the index. The dollar index has a weighting of 57.6% for the euro against the dollar currency pair.
The current bullish trend for the dollar index started in early 2021 when the index bottomed out at 89.165. Since then, the index has made higher lows and higher highs, almost reaching the 110 level on September 1, 2022. Currency trends often last for years, and the uptrend of the US Dollar continues to take it to new highs. multi-year highs as we head into the final months of 2022.
The bull fund Invesco DB USD (NYSEARCA:UUP) moves up and down with the index, while the UDN product works in the opposite direction.
New two-decade highs for the dollar index
The dollar index futures contract hit a low of 89.165 in early January 2021. Since then, the index has been hitting higher lows and highs, surpassing a critical technical resistance level in May 2022.
The chart highlights the technical breakout that took the dollar index to a high of 110.260 on September 1. The last time the index topped 110 was in 2002. It closed at 109.510 on Friday September 2 and hit a new high on Monday September 2. 5.
The Fed remains determined to fight inflation
Interest rates are the primary driver of currency values when measuring one foreign exchange reserve instrument against another.
After describing the rise in inflation as “transient“and pandemic-inspired event for most of 2021, the explosive rise in the U.S. consumer and producer price indices prompted the Fed to carry out its accommodative monetary policy and a tidal wave of government stimulus during the COVID-19 pandemic sowed inflationary seeds that made the Fed backtrack in late 2021, paving the way for aggressive short-term interest rate hikes and launching a program to reduce its bloated balance sheet by allowing debt securities to retire at maturity When US interest rates rose, the US dollar strengthened as a higher yield made the dollar more attractive than the euro and other currencies of the dollar index.
Meanwhile, US GDP has seen two consecutive quarterly declines, the classic definition of a recession. Raising interest rates to fight inflation stifles economic growth. Therefore, fighting inflation with hawkish monetary policy only exacerbates recessionary pressures. The Fed and the Biden administration called the drop in GDP “economic”transition“and run the same risk as in 2021, calling the rise in prices “transient.”
At the recent annual conference in Jackson Hole, Wyoming, Fed Chairman Jerome Powell and other Fed economists reiterated their hawkish commitment to fighting inflation through higher interest rates, ignoring economic contraction. The latest August jobs data showed the unemployment rate edged up to 3.7%, with non-farm payrolls rising by 315,000, which was the market expectation. The jobs data is unlikely to deter the central bank from raising the federal funds rate by 50 or even 75 basis points at the next FOMC meeting in September.
Ultimately, US monetary policy is one of the factors that has ignited a bullish fuse under the US dollar over the past few months and sent it to the highest level in twenty years.
The downtrend of the euro
Meanwhile, the war in Europe is creating an almost perfect fundamental bullish scenario for the US Dollar, which is putting enormous pressure on the Euro currency. The euro has been trading at par with the US dollar for two decades. The euro’s exchange rate against the US dollar was below parity on September 5 after falling steadily since the start of 2021.
The chart shows the bearish trajectory of the lower resistance of the Euro against the Dollar since its failure at $1.2349 in early January 2021, reaching its most recent low of $0.98785 on September 5.
The war between Russia and Ukraine is on Europe’s doorstep. NATO countries supporting Ukraine and sanctioning Russia, the Russians fought back. Russia supplies Europe with traditional energy raw materials, which have become a weapon in economic warfare. Moreover, Ukraine and Russia are the breadbasket of Europe, which has an impact on the food supply. In 2022, the prices of crude oil, natural gas, coal, corn, wheat and other agricultural raw materials and biofuels have skyrocketed. With Europe in Russia’s sights and the potential for conflict crossing the Ukrainian border to the west, the euro fell. Given that the euro represents 57.6% of the dollar index, the war has only added downward pressure on the index, intensifying the impact of rising US interest rates. .
Currency trends are slow and steady
Governments around the world operate foreign exchange markets to stabilize cross-border payments and the global financial system. Therefore, currency volatility tends to be much lower than the variance of stock, bond, and commodity market prices.
The chart highlights the weekly historical volatility of the E-Mini S&P 500 futures contract which stood at 20.33% on September 2, 2022.
The weekly US Government 30-Year Treasury Bond futures chart shows a historical price spread of 12.35%.
NYMEX WTI crude oil futures had a historic weekly volatility of 34.1% on September 2.
Meanwhile, the dollar index measure came in at 8.1%, reflecting the absence of wide price ranges in the realm of exchange between reserve currencies. While currency volatility is lower, currency trends tend to last for long periods of time. The dollar index had an upward trend from 1992 to 2001 and a downward trend from 2001 to 2008. The long-term pattern of higher highs and higher lows in the dollar index is now fourteen years old and does not show no signs of shortness of breath. Central banks, governments and monetary authorities could seek to slow the rise of the American currency. Still, interest rate differentials and the war in Europe are supporting the dollar against the constituent members of the index.
UUP is the ETF product pegged to the bullish dollar
The most direct route to a risk position in the US dollar index is through futures contracts on the Intercontinental Exchange (ICE). For those looking to participate in the rise of the dollar without venturing into the futures market or the global OTC forex market, the Invesco DB USD Index bull fund is moving higher and higher with the index. . UUP’s bearish counterpart, the UDN product, works the other way around.
At the $29.38 per share level on September 2, UUP had $2.051 billion in assets under management. The Fund trades on average more than 3.9 million shares per day and charges a management fee of 0.78%. The bearish UDN product at $17.52 had $71.884 million in assets under management. UDN trades an average of 141,895 shares per day and charges an expense ratio of 0.77%.
The dollar index rose from 89.165 at the beginning of 2021 to 109.980 on September 1, 2022, an increase of 23.3%.
During the same period, the UUP rose from $24.09 to $29.47 per share or 22.3%.
The bearish UDN product fell from $21.91 to $17.49 per share over the same period, a decline of 20.2%. The UUP and UDN products do a great job of tracking the dollar index up and down. UUP and UDN only trade during the hours of operation of the US stock market. Therefore, they may miss highs or lows that occur outside of US stock market hours. The dollar index hit a new two-decade high on Monday, September 5, the US Labor Day holiday, when the UUP and UDN were not available for trading.
At the beginning of September 2022, the trend of the dollar index remains upwards. While uptrends rarely move in a straight line and the odds of occasional corrections increase with levels, the dollar remains the strongest fiat reserve currency in the world, with rising US interest rates and geopolitical unrest in the making. Europe, a bullish wind behind the sails of the dollar.
The end of European hostilities and a shift in Fed policy to address growing recessionary pressures are potential headwinds to higher highs in the Dollar Index. Still, the outlook seems dim for these happenings any time soon.