The U.S. dollar is getting crushed — here’s why you can thank the Fed

The U.S. dollar fell sharply versus major currencies Thursday, with bears taking the Federal Reserve’s reassurance that it won’t be soon tapering its bond purchases as a green light to sell the currency.

“The latest blow to the dollar came from the Fed, which vowed not to touch policy even if the outlook for the U.S. economy brightens as it now expects,” said Joe Manimbo, senior analyst at Western Union Business Solutions.

Weakness also reflected rising expectations that Washington lawmakers will finally agree on an economic rescue package that’s seen as necessary to shore up a sagging recovery, he said.

The ICE U.S. Dollar Index, which measures the currency against a basket of six major rivals, slumped 0.7% to 89.828, trading below 90 for the first time since April 2018. It’s down 6.8% so far this year.

U.S. Dollar Index (DXY)Source: FactSetAs of Dec. 18, 2:29 p.m. ET

Moreover, the index has dropped nearly 13% since March, when it spiked to a more-than-three-year high as the COVID-19 pandemic plunged the U.S. economy into recession and sparked a bout of chaos in financial markets, driving global investors into the safety of the world’s reserve currency.

The dollar’s selloff on Thursday was broad:

  • The euro EURUSD, the most heavily weighted component of the DXY, rose 0.6% to $1.2270, hitting its highest level versus the dollar since April 2018. For the year to date, the shared currency is up more than 9%.
  • The dollar fell to a more-than-three-year low versus the Japanese currency USDJPY, 0.20%, declining 0.4% to ¥103.07.
  • The British pound GBPUSD, -0.55% was up 0.5% at $1.3575, its highest since April 2018.
  • Currencies that typically rally in line with equities, commodities and other assets perceived as risky were doing just that, with the Australian dollar AUDUSD, -0.10% and the New Zealand dollar NZDUSD, -0.32% each up 0.6% versus their U.S. counterpart. The dollar was off 0.1% versus the Canadian dollar USDCAD, 0.55%.

U.S. stocks pushed higher Thursday, with the S&P 500 SPX, -0.72%, Dow Jones Industrial Average DJIA, -0.70%, and Nasdaq Composite COMP, -0.25% closing at records.

A falling dollar is typically seen as a positive for U.S. and global equities as well as the world economy. It’s also seen as the potential missing ingredient for a bullish turnabout in commodities priced in the dollar.

The Fed, in its last policy meeting of 2020, on Wednesday reassured investors the central bank would maintain its easy monetary policy stance, including its bond-buying program, until the economy shows “substantial progress” toward recovering from the damage inflicted by the virus.

Fed Chairman Jerome Powell, in his news conference, indicated the central bank wouldn’t be hasty in unwinding its monetary stimulus measures even though the central bank’s economic forecasts appeared a bit more upbeat than previous iterations.

“The FOMC’s dot-plot looked hawkish…Mr. Powell’s comments were anything but,” wrote Kit Juckes, global macro strategist at Société Générale, referring to the individual rate forecasts produced by members of the policy-setting Federal Open Market Committee.

Of course, other central banks are also employing extraordinary measures aimed at supporting their economies. And while a weaker dollar is viewed as generally positive for the U.S. and global economy, it’s been a source of consternation for some rivals, including the European Central Bank.

But an important part of the tale centers on interest rates — particularly the differential between yields on bonds in the U.S. and elsewhere. While Treasurys still yield more than, say German government debt, that differential has shrunk, reducing the incentive to hold U.S. paper and weakening a source of support for the dollar.

The spread between U.S. TMUBMUSD02Y, 0.121% and German two-year yields TMBMKDE-02Y, -0.712% has narrowed from 215 basis points, or 2.15 percentage points, to around 90 basis points this year, noted Mark Haefele, chief investment officer for UBS Global Wealth Management.

Dollar weakness “also reflects the improved prospects for more pro-cyclical currencies amid recent positive vaccine news and a corresponding decline in demand for safe-haven assets,” he said, in a Thursday note, referring to the dollar’s tendency to find support during periods of turmoil.

“Meanwhile, the prospect for further U.S. fiscal stimulus, with Congress continuing to debate the details of a $900 billion COVID-19 aid bill, is likely to keep U.S. indebtedness in focus, adding to pressure on the greenback,” Haefele said.

Add in improving prospects for a trade deal between the European Union and the U.K., a compromise last week that unblocked the path to a $2.2 trillion EU recovery fund, and the continued rollout of COVID-19 vaccines and the stage is set for the dollar to keep falling, Juckes wrote.

“The only problem is that it’s falling too fast,” he said, noting that SocGen’s fourth-quarter euro forecast put the shared currency at $1.27, around 4% above its current level. The euro has risen around 3% in the last month alone.

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