Dollar back in the driving seat!

The US central bank, the Federal Reserve raised rates on Wednesday evening by 0.25% and whilst that was entirely expected by the markets, there was some doubt as to whether or not they would look to repeat that again this year.

Well, the Fed boss, Jerome Powell and his colleagues pretty much removed those doubts when it became known that 12 of the 16 FOMC (Federal Open Market Committee) voting members of the US central bank favoured another rate increase before the end of the year.

Now, some very high profile players in the market have been arguing strongly over the past few weeks for the dollar to fall; from what they see as an already overvalued and ‘over populated’ position. Well, the dollar surely didn’t listen to those calls yesterday as it rose against all of its major counterparts, recovering some of the ground it has lost in recent weeks.

The EURUSD fell back through 1.17 and the USDJPY closed above an important level (113.24) yesterday evening, posting a new 2018 high. If the dollar can maintain those gains for the close tonight that would send a strong signal that it may have further to rise against the Japanese currency. My view for whatever it’s worth; is that over time, quite a long way.

The pound didn’t escape the dollar’s tailwind either as that fell back below 1.3100 yesterday and looks set for further losses (leaving aside any domestic excuses to fall) if the current dollar momentum keeps going. The economic news stateside is good too and with growth outperforming all its peers still, its no wonder the US currency is vogue, be it relatively over-valued or not.

However, when one looks at a simple chart one can see that in relative terms over the past month the USD index has actually come down quite a way from its highs in August. So is it really that overvalued anyway?

For the most part this dollar rebound is not so much about punters backing it per say, but more the cost of betting against it. That’s simply because of the interest rate differential in the dollar’s favour.

You see US interest rates were already markedly higher than those in Japan and Europe before this latest move, which has only served to further highlight the difference. In fact, when one looks at the bond yields on offer in Germany compared to those on offer stateside the difference is stark.

Believe it or not, right now buying 2 year German government bonds will actually cost you money: -0.50% to be more precise. Yes, you did read that right; you can give the German government money for 2 years and at the end of the term they will give you back ½ % less than you invested! Now, make the same investment for the same duration with good old Uncle Sam and he’ll pay you more than 2.8%.

Consequently, its no surprise that the US dollar is smiling its socks off at the moment and whilst some may not like that; even if the dollar just stands still, betting against it is a costly exercise.