Market Overview

Investors are taking into account the notion of a weakening U.S. Dollar amid expected monetary easing by the Federal Reserve (Fed) as the banking crisis evolves. There is a solid reason behind it, and markets are betting on it despite the Fed’s commitments to continue with monetary tightening. But are these expectations justified considering that it was investors who aggressively pushed the Greenback down last fall and summer?

What are the real doubts behind the strengthening of the Dollar?

First, the Fed is likely to continue with its hawkish monetary stance until the end of 2023, as it promised. Monetary policymakers are set to increase interest rates to 5.1% in average for the rest of the year. However, the monetary policy of the Fed is forcefully controversial. The Fed has to be both hawkish with rising interest rates and dovish when it comes to the inflating monetary supply and its balance. The latter rose by 5% to $8738 billion in two weeks ended March 21. This is merely $400 billion! The Fed has gradually reduced its balance by $620 billion from $8962 billion just a year ago. So, two thirds of these tough efforts were wiped out in 14 days!

Then the Fed had the same balance as it had in October 2022. Inflation was at 8.2%, and the U.S. Dollar index (DXY) was at 113 points. The same situation can be seen now, but inflation is at 6% and DXY is at 102.3 points. These are two absolutely different perspectives, and the second is very distorted and worrying. Among other issues, it may mean accelerated inflation in 2-4 month, at the moment when investors expect the Fed to lower its interest rates. Foremost, the Fed has an inflation control mandate. The monetary watchdog has confirmed its Core Personal Consumption Expenditures (PCE) target at 3.1% by the end of 2023 after inflation figures at 5.4% in February. The adjusted data will be published on March 31. If the index climbs up by the summer, any thoughts of monetary easing by the Fed would be too premature. The Fed has bravely announced that it will continue with clearing up its balance sheet.

Second, the Fed understands that the current banking crisis is not a systemic one. It sees it rather as an isolated issue with some of the noise around some of the banks reaching higher levels because of panic. So, in its eyes the U.S. banking system is strong, but requires some more liquidity for a limited time. With this in mind, hawkish monetary policy could hardly add negative implications. The Fed is accepting the defaulted banks’ assets at nominal value as collateral in exchange for providing additional liquidity. So, even if the hawkish monetary policy does push the price of these assets down, it would hardly affect the financials of these banks as they will receive the necessary liquidity. Rising interest rates is expected to not provide further steam for any more issues in the banking system.

Third, recession risks. The banking crisis and rising interest rates across many developed nations, including the European Union, the United Kingdom, and some others increase the chances of a hard landing for the global economy. The United States, with its strong economy, will suffer less than other economies during the recession. The Fed expects  GDP to climb by 0.4% this year and by 1.2% in 2024. So, it is not afraid of a recession. The Dollar may act as a safe haven asset during economic turmoil with U.S. Treasuries receiving insane demand. The European Central Bank (ECB), that lifted its interest rates by 0.50 percentage points, could be rather limited when it comes to further rate hikes amid rising recession risks, as the Eurozone economies are seen to be weaker compared to the U.S. with stronger negative implication for banks and economies within the EU, which are overloaded with debt. So, the upside potential of the Euro to the Greenback could be rather limited.

All the above could result in the strengthening of the U.S. Dollar with a strong support for the U.S. Dollar index at 100.6 points, the lows of 2023. In case of an upside move above the strong resistance of 103.2, the index may accelerate towards 105-106 points.

The market is largely irrational though and the factors mentioned above may not be enough to stop the Dollar sell-offs. The banking crisis is also far from a happy ending. Thus, anything could happen amid the uncertainty.

Disclaimer:

Analysis and opinions provided herein are intended solely for informational and educational purposes and don't represent a recommendation or investment advice by TeleTrade.