The US Dollar Could Be In A Win-Win Position

The US Dollar Could Be In A Win-Win Position
Luke Suddards

9 months ago2 mins

The US dollar has been making a comeback of late. This chart shows the US dollar index, which tracks the greenback against a basket of foreign currencies.

Interest rates are one of the biggest drivers for currency strength and weakness. That makes sense: higher interest rates can make a currency more attractive for international savers and investors. And right now, interest rates – and interest rate expectations – are giving the greenback something of a boost. In mid-January, investors thought the Fed’s peak rate would still be below 5% (close to where it is now), but increasingly, they are anticipating a peak around 5.4% now.

See, investors have been looking at the recent run of standout US economic data – employment, inflation, and retail sales – and realizing that the Federal Reserve is probably not as close to declaring “mission accomplished” in its battle against inflation as previously thought. They’ve begun to expect that the Fed will have to raise rates higher, and hold them there for longer, to bring inflation sustainably back toward its 2% target.

But if rising US interest rates are creating a pretty strong tailwind for the dollar, so is the greenback’s status as the world’s go-to currency in times of turbulence. You can use the S&P 500 as a proxy for risk appetite: when it’s rising, investors are hunting out riskier assets, but when it’s falling, as it did last week, investors are looking for safety.

Now, if other major central banks move in tandem, hiking their rates further, the risk of a global “hard landing” (i.e. recession) could rise, and that would lead to a risk-off vibe for stocks and increased flows into the safe-haven dollar.

Morgan Stanley’s top trade at the moment is to buy the US dollar against its lowest-yielding advanced economy peer, the Japanese yen (i.e. go “long” USD/JPY, with a target of 142 and a stop-loss at 132. If this idea resonates with you, you could buy the dollar against the Japanese yen via your broker or consider the Invesco CurrencyShares Japanese Yen Trust (ticker: FXY; expense ratio: 0.4%).



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