In a mid-August Barchart article, I highlighted the bounce from the July dollar index low to over the 102 level. Over the past months, the index that measures the U.S. currency against the other world reserve foreign exchange instruments has risen to the 107 level. Bullish and bearish factors are pulling the dollar index in opposite directions, but the path of least resistance has been higher since the July 2023 low.
Interest rates support a higher dollar index
In the foreign exchange market, interest rate differentials play a significant role in the value of one currency versus others. The dollar index measures the U.S. currency against the euro, Japanese yen, British pound, Canadian dollar, Swiss franc, and Swedish krona. The U.S. short-term Fed Funds Rate has increased from zero percent in March 2022 to 5.375% in October 2023, a dramatic rise. Moreover, quantitative tightening to reduce the U.S. central bank’s swollen balance sheet has pushed rates higher on deferred government debt securities. The U.S. bond market has been in a bearish trend since the March 2020 peak.
The chart highlights the long bond futures decline and pattern of lower highs and lower lows since the March 2020 high. In early October 2023, the long bond futures fell to a 108-29 low, the lowest level since August 200.
Rising rates tend to support the U.S. dollar index, which has risen from the July lows. In 2020, as U.S. interest rates rose, the dollar index exploded to the highest level in twenty years.
The chart illustrates the index’s rise to 114.78 in September 2022, the highest level since 2002. Since then, the index corrected, probing below the 100 level in July 2023 before climbing to the most recent 107.35 high in early October. Rising interest rates support the U.S. dollar.
Geopolitics support the U.S. currency
The geopolitical landscape remains a mess. The Chinese-Russian alliance and war in Ukraine bifurcated the world’s nuclear powers. China’s plans for Taiwanese reunification have caused relations between Beijing and Washington to deteriorate. The latest blow to world peace came last weekend when Hamas brutally attacked innocent Israeli and foreign citizens, causing the Israeli government to declare war on the terrorist organization. Meanwhile, funding from Iran and the threat of other attacks from the West Bank and Lebanon could cause an escalation over the coming days and weeks. The U.S. moved military vessels to the region.
Historically, geopolitical danger has caused assets to flow to the U.S. dollar and U.S. bond market. However, the unprecedented landscape does not guarantee the same flows over the coming weeks and months.
Domestic U.S. issues are another story
While the geopolitical environment is a mess, the U.S. domestic political landscape remains divided. The Republicans in the House of Representatives did not have the votes to prevent the recent firing of the Speaker of the House and are fighting over his replacement. The leading candidates for the 2024 Presidential election, incumbent President Joe Biden and former President Donald Trump, face horrible approval ratings.
U.S. domestic political division while the world has become a hornet’s nest of conflicts and deteriorating relations creates a dangerous and volatile outlook. U.S. domestic discord is not bullish for the dollar and is bearish for the bond market, which both rely on the full faith and credit of the U.S. government.
Support and resistance levels in the dollar index to keep on your radar
From a short-term perspective, the U.S. dollar index broke out of the bearish trend from the September 2022 high.
The chart shows that while the dollar index was in a bearish trend from the September 2022 high to the July 2023 low, making lower highs and lower lows, the trend reversed to bullish when the index traded above the late May 2023 104.70 high.
Support is at the 104.70 previous resistance level, with the next resistance at the November 2022 113.15 high. The dollar index has room to rally, but the recent price action turned slightly bearish above the 107 level.
UUP and UDN track the U.S. dollar index higher and lower
The most direct route for a risk position in the U.S. dollar index is via the futures contracts on the Intercontinental Exchange. The UUP and UDN ETF products reflect changes in the dollar index. UUP moves higher with the dollar index, while UDN moves higher when the dollar index declines.
At $29.65 per share, UUP had over $597.88 million in assets under management. UUP trades an average of nearly 1.4 million shares daily and charges a 0.77% management fee.
At $18.48 per share, UDN had nearly $63.6 million in assets under management. UDN trades an average of nearly 83,000 shares daily and charges the same 0.77% management fee.
The dollar index rose 7.8% from 99.58 on July 14 to 107.350 on October 3.
Over the same period, UUP rose 9.1% from $27.55 to $30.07 per share. The index 1.67% fell to 105.56 on October 10.
UDN increased 1.87% from $18.16 to $18.50 per share during the most recent correction.
UUP and UDN are only available for trading during U.S. stock market hours. Since the dollar index trades around the clock, the ETFs could miss highs or lows when the stock market is not operating.
Expect high price variance in the dollar index over the coming weeks and months as the forex market reflects the economic and geopolitical landscapes that are highly volatile in October 2023.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
