The Less-Mighty Dollar

Those of us who live in the U.S.A. are a bit spoiled.  We’ve benefitted from the “almighty dollar” for quite some time, especially when we travel abroad or buy imported goods and services.  That said, two key dollar indices just hit multi-year lows this morning, with both in well-defined downtrends.  Good news about inflation is playing a role.

There are of course myriad ways to trade the dollar versus other currencies, but there are two main ways to track the dollar against a basket of currencies: DXY and BBDXY.  The two indices are generally similar, but this graphic from the CME portrays how BBDXY is a bit broader:

BBDXY vs. DXY

Source: CME Group

Past performance is not indicative of future results

Regardless of their similarities and differences, both indices are showing notable weakness.  The broader BBDXY hit a low not seen since July 2022:

3-Years, Daily Data: BBDXY (blue/white candles), 50-Day Moving Average (yellow)

Source: Bloomberg

Past performance is not indicative of future results

DXY took out a low that was set only in April, but that was a 3-year low of its own:

3-Years, Daily Data: DXY (blue/white candles, left scale), 50-Day Moving Average of DXY (yellow line, left), 2-Year US Treasury Yield (blue line, right)

Source: Bloomberg

Past performance is not indicative of future results

The second graph adds a feature that helps explain why this current trend is meaningful.  Yields influence the relative value of one currency versus another.  All things being equal, a currency that offers a higher risk-free rate should trade at a relative premium to one with a lower rate.  Of course, rarely do we see all things being equal on a day-to-day level, but it is quite clear that for the most part, the dollar basket broadly follows the path of US short-term rates.   It is even more apparent when we look at a 5-year chart:

5-Years, Daily Data: DXY (blue/white candles, left scale), 50-Day Moving Average of DXY (yellow line, left), 2-Year US Treasury Yield (blue line, right)

Source: Bloomberg

Past performance is not indicative of future results

The recent divergence between interest rates and the dollar is what gives us pause.  DXY peaked around the recent inauguration, likely bolstered by the incoming President’s “America First” message.  In hindsight, it is possible, if not likely, that relative to moves in rates, currency traders showed a bit too much enthusiasm for the USD.  But remember, all things are rarely equal.  The stronger dollar during the post-election period was a theme of its own.  Markets can and do indeed do such things all the time.

But now the theme has shifted.  Much of the speculative money that flowed into the USD after the election began to leave in earnest after tariff talk dominated the news cycle.  There was a bit of a wave after the “Liberation Day” announcement; those flows have ebbed, but we still see the tide going out.

This is why it is important to view dollar declines in different perspectives.  On a day like today, some dollar selling should be expected.  This morning’s better-than-expected PPI report, coming on the heels of yesterday’s better-than-expected CPI report, has led to a 5-basis point decline in rates across the yield curve.  Lower inflation raises the likelihood that could cut rates in the near future, hence lower yields on notes and bonds, hence a weaker dollar.  That’s a virtuous circle.  It’s the opposite that indicates likely outflows – when the dollar falls even as rates are stable or rising. 

Is this cause for immediate concern?  Not necessarily.  For starters, a weaker dollar helps the bottom lines of multinational companies.  Almost all the most important stocks have global operations.  A weaker dollar means that non-USD revenues are worth more when translated into their USD-based income statements.  Thus, modest dollar depreciation is a boon to equity investors.  The concern grows if the dollar weakness reflects a wholesale move by foreigners out of US assets.  It would pressure bonds and stocks if international investors became major sellers on an ongoing basis.

We’re in the former stage now, not the latter.  During the next earnings season, we are likely to hear how the weaker dollar has been a relative boon to multinationals.  The latter remains on the horizon, and at least bears watching because that would pressure the positive momentum upon which we’ve come to rely.  On the flip side, a weaker dollar is a tailwind for those who invest in international equities.  The IBKR platform offers an awful lot of them…