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DOLLAR INDEX ON A SEE-SAW

Harvest Global Markets :

Since October, the dollar index, which gauges the dollar against a weighted currency basket, has been decreasing, and this month marked another decline. The most common explanation is differential interest rates. The enhanced yields of higher U.S. interest rates entice capital from outside. Thus, money flows from economies with lower yields to those with higher yields, boosting the dollar. Nonetheless, a crucial dollar tailwind is eliminated if the Federal Reserve slows or halts rate hikes. In the past two weeks, the dollar has fallen from a 20-year high as signs of falling inflation in the United States fuel anticipation that the Federal Reserve may soon reduce its rate hikes. The dollar has declined more than 4% against a basket of six rivals in November, putting it on course for its largest monthly decline since September 2010. It is up approximately 11% for the year to date.

 

Investors are examining early signs that U.S. inflation may finally be moderating, which could pave the way for the Fed to slow the rate at which it has been increasing interest rates. Some indicators, such as those in the housing and manufacturing sectors, have also shown that the economy is facing increasing headwinds, another factor discouraging the Fed from tightening monetary policy. After Russia invaded Ukraine, Europe was smacked by a big terms-of-trade shock. As energy prices rose, Europe’s purchasing power switched toward energy imports virtually overnight, transforming the eurozone from a trade surplus to a deficit. Typically, trade imbalances weigh on currencies.

 

Currently, the balance of payments and power appears to be shifting in the opposite direction. As US-China relations strengthen and Russia’s nuclear threats subside, geopolitical concerns may diminish slightly. Importantly for markets, Europe is doing better than many had anticipated. Reduced energy costs, fiscal stimulus, and a few lucky breaks have diminished the likelihood of a catastrophically severe recession.

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