The US Dollar Index (DXY) has fallen widely in the last two weeks, after hitting its two-decade high of 105; it has fallen to 3.20%.
Overvaluation risks grip the dollar market
The correction of the dollar in the last two weeks precedes twelve months of incessant buying.
recapitulating, the weight of the greenback against the basket of major foreign currencies grew by around 14.3% in a year, mainly as markets sought safe havens from fears of a hard-line Federal Reserve and, more recently, the military conflict between Ukraine and Russia.
Cash balances among global fund managers grew 6.1% on average since 9/11, as a recent Bank of America survey of 288 asset allocators showed. The report also noted that 66% of asset managers believe global earnings will weaken in 2022, leading them to hold “overweight” cash positions.
“The market has grabbed a lot of dollars in the last couple of months,” said George Saravelos, Deutsche Bank strategist told the Financial Times, adding that “this is leading to a very substantial overvaluation of the dollar.”
Therefore, the dollar’s latest pullback may have been a stopgap correction to neutralize its “overbought” conditions, as weekly readings of the greenback’s relative strength index (RSI) also suggest (in the graph below).
From a more technical point of view, DXY could continue to pull back towards an ascending trend line which, as support, has been limiting its moves lower since January 2021.as it’s shown in the following.
If further selling occurs, the index is likely to pull back from its current resistance range, with the next downside target at the 0.786 Fib line near 100.
Prospects for a stronger euro
DXY also pulled back earlier this week as Christine Lagarde, president of the European Central Bank (ECB), established a new tougher policy on May 23.
Lagarde pledged to raise interest rates by September 2022, thus moving away from the ECB’s accommodative monetary policy, which has led to de facto negative interest rates for a decade.
Consequently, interest rates in the Eurozone would shoot up to zero, the prospect of which has made the euro stronger against the dollar.
But even with the current crisis between Ukraine and Russia and their access to overflowing energy, Eurozone confidence in business growth remains strong, the recent IFO survey shows. This would be a further boost for the euro, which could push the dollar down.
“It is still too early to say for sure that the dollar has entered a weakening trend,” said John Authers, senior editor of Bloomberg Opinion, adding:
“But its decline is another sign that the ‘stagflation and rising rates’ narrative is being recast.”
Emerging Market Currencies vs. Bitcoin
A weaker DXY just represents its declining weight against foreign currencies. But a deeper look at the dollar shows weakening purchasing power in a high inflation environment. The consumer price index (CPI) exceeded 8% in April 2022.
Consequently, the dollar, although stronger than a year ago, has not been able to cause emerging market currencies to plummet, thus breaking their longstanding negative correlation.
In particular, yields on developing country currencies such as the Brazilian real and the Chilean peso have been higher than the dollar since January 2022.
Emerging market currencies tend to underperform when the dollar rises, mainly because investors look to the greenback as their last refuge in times of global market uncertainty. But with commodity prices soaring due to the Ukraine-Russia crisis, investors are rethinking their strategy.
In the meantime, countries that raise their interest rates are also creating a better investment environment for their currencies, says Stephen Gallo, European head of currency strategy at BMO Capital Markets.
Excerpts from his statements to the Wall Street Journal:
“Emerging market central banks are being forced to tighten policy to keep up with the Fed. Either that, or capital controls are imposed.”
The current power game between the dollar and emerging market currencies has left bitcoin (BTC) out of consideration. Its value has fallen by more than 50% since November 2021 and it is holding heavily with risk assets.
Nevertheless, bitcoin’s negative correlation with DXY has turned positive this week. This suggests that a further decline in dollar markets would not necessarily trigger a BTC price rally any time soon.
As Cointelegraph reported, calls for a macro bottom of $20,000 and even much lower are getting stronger as bitcoin struggles to break above the $30,000 mark again.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, so you should do your own research when making a decision.
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