One of the main drivers of currency performance is the monetary policy that central banks adopt. This is no different for the US Dollar and the FED. After two years riddled with volatility caused by a pandemic, The central bank is integrating a more hawkish tone to fend off increasing inflations and improving employment data.
That same hawkish stance translates to a slow tapering of asset purchases and an eventual hike in interest rates. While these things are long-term, the prospects of higher rates will immediately begin to make the Dollar seem attractive versus other currencies, especially those with zero or negative rates. The differential, especially as it widens, could bring back carry trading or the idea of holding currency pairs that yield a net positive interest.
The Dollar Index (Figure 1) dipped below 90.00 in early 2021 and then approached the same area around May-June before turning higher. According to analysts, the 89.00 zones are acting as support and now that it’s holding, higher prices could be expected. Traders are seeing resistance between 93.50 and 94.50 and will expect supply to come in around those prices.
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Figure 1 – Daily Dollar Index Chart
The consensus from traders believes that the US Dollar needs to break one way or another before a meaningful trend forms and with higher rates on the horizon, the odds are towards the upside. A higher Dollar could see a lower Euro and British Pound and that could affect economic and trade conditions between the countries.
While this is one scenario, any changes in the stance of the FED or other related central banks such as the BOE or the ECB could mean different outcomes. According to analysts, the ECB is also hinting at a more hawkish stance with tapering in the near term. All of this could end up creating a balance yet one of them will emerge as a winner in terms of the interest rate race.
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