2023-10-15 06:48:35 Eastern Standard Time
The advantage of financial markets is that they are closed on weekends. Investors have time to regroup, rethink their strategies and prepare for Monday’s trading.
Therefore, the weekend is a time for reflection.
It’s also a time when many people focus on the bigger picture, long-term trends, and how fundamentals are impacting the market.
Yesterday, I argued that higher long-term interest rates are the new central bank’s mantra. Today, I would like to take that discussion further and introduce a rather unpopular opinion about the world’s reserve currency.
More precisely, could a high interest rate environment lead to a weaker dollar rather than a stronger dollar? The narrative is that the dollar is going to get even stronger because everyone is talking about the Fed and high interest rates.
I beg to differ.
For this, we bring you the bigger picture: the EUR/USD monthly chart.
The US dollar strengthened as interest rates steadily fell
For decades, interest rates have fallen dramatically. But perhaps the most important period has been the past 10 to 15 years, when U.S. interest rates have been near zero.
Lower interest rates should be bad news for the currency. But it wasn’t about the dollars.
This is the monthly chart of EUR/USD. This represents the most significant appreciation of the US dollar since the Great Financial Crisis of 2008.
At the time, EUR/USD was trading above 1.60. Going back to the aftermath of the COVID-19 pandemic, EUR/USD traded below 0.96.
This is a steady decrease of dozens of large numbers (i.e. one large number equals 100 pips points) over a relatively short period of time.
But what’s interesting here is not necessarily the depreciation of the exchange rate, but the fact that interest rates in the United States have been falling all the time. Therefore, in a low interest rate environment, we see a stronger dollar.
The natural next question is, now that interest rates are so far off their lows, where will the dollar go? And if central banks keep saying that interest rates will stay high for a long time because inflation is likely to remain high, why don’t they sell the US dollar as the trend reverses?
In summary, the idea of these two interest rate-specific articles is that the long-term trend has reversed. Interest rates aren’t going down anymore and aren’t likely to go down anytime soon.
However, if the US dollar appreciates in a low interest rate environment, it stands to reason that it will depreciate in a high interest rate environment. Therefore, I recognize that any USD strength is only temporary as financial markets try to cope with rising interest rates.
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