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November 22, 2016

How Long will the Greenback Rally Last?

The US dollar index – a broad measure of the dollar’s performance against a basket of 6 weighted currencies, is on the rise. The DXY trades on the ICE, and it was last at 100.31 (November 16, 2016), up 0.20% or 0.20. The 52-week high on the US dollar index is 100.57 and the 52-week low is 91.92.

The DXY is one of the most important barometers of the strength of the greenback. It is a weighted index which is comprised of the following percentages:
·         JPY – 13.7%
·         EUR – 57.6%
·         CAD – 9.1%
·         GBP – 11.9%
·         CHF – 3.6%
·         SEK – 4.2%

What’s interesting about this index is that it if the USD is appreciating, it will typically be reflected in the DXY. Currency traders needn’t look at all the individual forex pairs comprising the USD and major, minor and exotic currencies. Several key developments are at work when it comes to evaluating dollar strength. Foremost among them is the Fed FOMC decision vis-a-vis interest rates. 

At the start of 2016, Fed chair Janet Yellen promised at least 2 rate hikes in the year. With just 1 Fed meeting left on Wednesday, 14 December 2016, expectations are high. The current probability for a rate hike is now at 90.6%. In other words, the federal funds rate is expected to rise by 25-basis points from its current range of 0.25% – 0.50% to 0.50% – 0.75%. The next Fed meeting will take place on February 1, 2017 and there is a high probability of a rate hike (87.4%) if the FFR isn’t increased next month.

Speculating on Price Movements in Forex Pairs

The implications of a rate hike on the USD are significant. For starters, higher interest rates indicate a greater yield on the greenback. Foreign investors will be eager to sell their currency and buy USD heading into December. This naturally creates excess demand for the greenback and an excess supply of currencies like the EUR, GBP, AUD, NZD, ZAR, CHF and CNY. Binary option traders are among a key group of speculators capable of cashing in with these types of profitable opportunities. 

Unlike conventional hard currency purchases, binary options traders simply speculate on future price movements of currency pairs. By correctly anticipating the direction, not size, of price movement, significant profits tend to be generated. This is done by way of call options and put options on a binary options trading platform.

What Other Factors Impact the USD?

There are multiple factors impacting the USD, notably US economic data releases. Things like industrial production, producer prices, retail sales and non-farm payrolls jobs growth are key to the strength of the greenback. Positive economic data releases spur a rally on Wall Street which generates increased demand for the USD. 

Recently, the USD hit a 13-year high on the US dollar index. When the DXY was at 100.5, it represented the highest level since 2003. This is being boosted by hopes of massive fiscal expansion with the Trump administration. Recall that the Fed has set an inflation target of 2%. With full employment reached at the current level of 4.9% unemployment, the Fed is moving full steam ahead towards quantitative tightening.

Fiscal expenditure and monetary tightening are perfect drivers of higher inflation and a stronger USD. Add to that Trump’s call for protectionist measures for US enterprise and the repatriation of trillions of dollars in overseas holdings, and it’s a recipe for economic dynamism. During the last week, the DXY increased by 1.96% and as much as 2.60% over the past 1-month period. All major currencies are down against the greenback (November 16, 2016), including the EUR/USD (-0.41%), GBP/USD (-0.12%) and the AUD/USD (-1.06%). This trend is likely to continue in coming days and weeks as we move closer towards the Fed decision and Trump’s inauguration as the 45th President of the United States.

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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