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The Stronger Dollar

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Summary

  • Since January 6, 2021, the value of the U.S. dollar has become stronger, and it continues to do so as the U.S. stock market continues to hit new historical highs.
  • The Federal Reserve seems to be behind the rise in the stock market, and the feeling is, at present, that the Federal Reserve will continue to support the stock market.
  • In addition to the strong stock market, the U.S. seems to be outperforming other major countries in terms of its success in vaccinations against the Covid-19 virus.
  • The two of these combined seem to be making the U.S. dollar attractive against other currencies, and this is expected to continue, at least, into the summer.

The value of the U.S. dollar continues to stay strong. The reason seems to be that the U.S. is expected to outperform other countries in both its response to the Covid-19 pandemic and in terms of its recovering economy.

As I wrote last week:

"Now, the U.S. economy looks as if it may outperform many others, and it looks like the pace of vaccinations is gaining momentum so that the future looks relatively brighter."

Hence, investors want more dollars.

What Has Happened This Quarter?

The value of the U.S. dollar has gotten stronger over the last three months. On January 6, 2021, the U.S. Dollar Index (DXY) hit a near-term low of 89.42. Yesterday, this index closed at 93.28, up 4.3 percent.

At the earlier date, it took $1.2324 to acquire one euro. Yesterday, at the close, the euro only cost $1.1720. This represented a 5.2 percent rise in the value of the dollar versus the euro. In trying to determine what is going on here, the only other major market that seemed to be moving in this same direction was the stock market.

In terms of the stock market, we find that the Standard & Poor's 500 Stock Index closed on January 6 at 3,748. On March 30, the S&P 500 closed at 3,959, an increase of 5.6 percent.

During this interval, the S&P 500 Stock Index hit 15 new historic highs, the latest occurring on March 26 when the index closed at 3,975.

The U.S. bond market did not move in a similar way. That is the yield on the 10-year U.S. Treasury note went from 1.003 percent on January 6 to 1.724 percent on March 30. Thus, a lot of bond selling went on to lower the price of the security so that the yield could rise.

So, it looks like investors were buying U.S. dollars and money was flowing into the United States. It appears as if investors were selling U.S. Treasury notes. And it appears as if investors were buying common stocks.

What Is Moving What?

The question is what is going on here?

Well, my argument has been that there seems to be a strong connection in the United States between the actions of the Federal Reserve System and the U.S. stock market.

My argument goes back 10 or 11 years or so, beginning with the efforts of Ben Bernanke, Fed chairman, and the Fed to not only get the U.S. economy to recover from the Great Recession, but also to keep the economy growing once the expansion began. The foundation of the monetary policy under Mr. Bernanke was to get the stock market to rise so as to create a wealth effect so that consumers would start to spend and then would keep spending.

Mr. Bernanke was successful, but this effort also impressed investors concerning the connection between the monetary efforts of the Fed and the performance of the stock market. We seem to have reached the point when investors place a lot of weight upon what the Fed is saying and what the Fed is doing, and the stock market responds to what investors interpret.

Right now, we seem to be in a situation where the Federal Reserve is providing ample market liquidity to the stock market, and as a consequence, we are hitting all sorts of new historic highs.

But what about the value of the dollar?

Dollar Strong

The dollar has gotten stronger during this last quarter at the same time that the Fed is pumping so many dollars into the banking system. Usually, the movement is in the opposite direction.

This time around, it seems as if something else is dominating the movement of the dollar. Here, it seems as if the current success in the vaccination efforts of the United States against the Covid-19 pandemic is having a major impact.

Although the U.S. has a long way to go, it has appeared, since the start of the year, that the vaccination process in the United States has been much more successful than in other areas of the world, especially of the developed world. This fact has important economic implications. It means that the U.S. can open up its economy and get the economy moving faster than other countries around the globe.

This seemingly has had an important impact on the value of the U.S. dollar.

So, foreign dollars can flow into the United States, which pushes up the value of the dollar, and these monies can then go into the stock market, which seems to be responding strongly to the efforts of the Federal Reserve to keep it strong.

The one little hitch in this whole scenario is that the efforts by the Federal Reserve, now connected with the new stimulus programs of the United States government, is that all these efforts are raising issues about inflation.

As I have recently discussed, concerns about inflationary expectations are popping up all over the place. For example, the inflationary expectations built into the yield on the 10-year U.S. Treasury note have risen from around 2.05 percent on January 6 to around 2.40 percent on Tuesday.

That is, given the current environment, an investor, whether from the U.S. or abroad, does not want to be in longer-term government securities. Consequently, the U.S. term structure curve has risen substantially over the past three months.

Going Forward

It appears as if this scenario is going to last into the springtime. Mr. Powell and the Federal Reserve certainly seem adamant about sticking to a policy that will support the stock market, but that will also support the government spending programs.

However, the future of inflation is not known, especially in this time of radical uncertainty. Let's just say that for the next few months, the value of the U.S. dollar is likely to remain strong. Later this summer we probably will need to review the whole picture once again.

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