As the stock market celebrated new all-time highs this past week, the foreign exchange markets, commonly known as the forex, have taken on a quite different tone — one of rising concerns about the direction of the world’s reserve currency: the U.S. dollar. The forex is the largest and most liquid market in the world, trading trillions of U.S. dollars on a daily basis. Key participants are central banks, commercial banks, investment banks, hedge funds, sovereign funds, forex brokers and retail investors. The forex market operates 24 hours a day, five days a week.
The anticipation leading up to the Fed’s half-point rate cut had traders pressuring the dollar lower to a closely watched technical level — that being 100.00 for the U.S. Dollar Index (DXY), which measures the value of the dollar relative to a basket of six major foreign currencies that includes the Euro, Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc. The DXY is heavily weighted toward the Euro because it represents the largest and most significant trading partner of the United States among the currencies in the index.
In the past six months, the value of the Euro is up by 3.19%, the Pound Sterling by 5.82%, the Canadian Dollar by 0.27%, the Japanese Yen by 5.32%, the Swedish Krona by 1.98% and the Swiss Franc by 5.88%. While these numbers may not sound significant, they matter greatly to international trade and are heavily influenced by central bank monetary policy and government fiscal policy. And though the monetary and fiscal policies matter among these six economies, they pale in size and significance to that of the U.S. economy.
As of 2023, the global GDP was approximately $105.4 trillion, of which the U.S. economy accounted for $27.4 trillion, or roughly 26% of total global GDP. The U.S. economy drives the global bus of economic growth. If the U.S. slides into recession, it has a major ripple effect. A stable dollar is vital to the stability of world trade, especially oil. In 2024, there are 23 countries whose currencies are pegged to the U.S. dollar. They include Hong Kong, Saudi Arabia, the UAE, Qatar, Oman, Jordan and even Venezuela.
The Fed’s slashing of rates now is intended to maintain the notion of a soft landing. At the same time, the Fed is currently reducing its bloated $7.1 trillion balance sheet, but at a slower pace than before. This process is called quantitative tightening, or QT, where reducing the money supply can exacerbate an already slowing economy. Reduced liquidity can lead to tighter financial conditions, but the market senses the lowering of the fed funds rate now and, going forward, will provide a strong offset.
Of importance here is how the dollar responds to the converging bearish forces of falling interest rates and soaring national debt, currently increasing at a pace of $1 trillion every 100 days, and now standing at $35.4 trillion. Neither Kamala Harris nor Donald Trump have said much about the nation’s deficits on the campaign trail, suggesting that the economic problem will only worsen in the next four years. Based on recent estimates, spending on older Americans is set to spike, and a new administration and Congress need to figure out a way to reach some bipartisan goals on fiscal policy.
At present, both the bond and stock markets do not seem to have much concern about what appears to be an issue that will likely reach an inflection point well before what current estimates predict. Recent Treasury auctions are being met with decent demand; however, one has to wonder about how much the global market will absorb before it demands a higher coupon to compensate for a dollar that has entered a new downtrend. Not having a crystal ball, just keep an eye on the DXY.
