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A weaker dollar in a high interest rate environment

By: Invezz
Cynthia Lummis’ crypto bill supported by New York senator

The beauty of financial markets is that they are closed over the weekend. Investors have time to regroup, rethink their strategies, and prepare for Monday’s opening.

The weekend is, therefore, a time for reflection.

Also, it is a time when many look at the bigger picture, long-term trends, and how the fundamentals may influence markets.

Yesterday, I argued that higher interest rates for longer is the new central banks’ mantra. Today, I want to build up on that argument, introducing a rather unpopular opinion regarding the world’s reserve currency.

More precisely, can a high interest rate environment bring a weaker rather than a stronger dollar? Everybody speaks of the Fed and the high funds rate, so the narrative is that the dollar will only get stronger.

I beg to differ.

For this, I bring you the bigger picture – the EUR/USD monthly chart.

The US dollar got stronger while interest rates declined steadily

For decades, interest rates have fallen dramatically. But perhaps the most important period was in the last ten to fifteen years when interest rates reached close to zero in the United States.

Declining interest rates are supposed to be bad news for a currency. But it wasn’t for the dollar.

This is the EUR/USD monthly chart. It shows that the US dollar strengthened considerably since the 2008 Great Financial Crisis.

EUR/USD chart by TradingView

Back then, the EUR/USD was trading above 1.60. Fast forward to the aftermath of the COVID-19 pandemic, and the EUR/USD traded below 0.96.

That is a steady decline of tens of big figures (i.e., one big figure equals one hundred pips points) in a relatively short period.

But what is interesting here is not necessarily the decline in the exchange rate but the fact that interest rates have fallen in the United States all this time. Hence, we’ve seen a stronger dollar in a low interest rate environment.

Naturally, the next question is, where would the US dollar go now that interest rates are well off their lows? Also, as central banks keep telling us that interest rates are higher for longer as inflation is likely to remain elevated, why not sell the US dollar as trends reverse?

Summing up, the idea of these two articles dedicated to interest rates is that long-term trends have reversed. Interest rates are not falling anymore and aren’t likely to fall anytime soon.

But if the US dollar strengthened under a low interest rate environment, it is only logical that it will decline in a high interest rate environment. Hence, I perceive any US dollar strength to be just temporary as financial markets grasp to cope with rising interest rates.

The post A weaker dollar in a high interest rate environment appeared first on Invezz.

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