Last week, FXCM's USDOLLAR basket completed a bullish reference candle. I.e. it closed above the reference candle's high (top blue arrow) . This pattern lays the foundation for a potentially higher greenback in the future.
A bullish reference candle accompanied this on the weekly real rate chart. I.e. Last week's real rate closed above its reference candle (bottom blue arrow). Again, whilst not a guarantee, this lays a footing for higher real rates.
The dollar has a robust positive correlation with real rates (red shaded area). Moreover, the QT programme has influenced this correlation to a large degree. The red dashed vertical is the week the Fed confirmed its intent to normalise its balance sheet, which, we believe, led to the strong correlation coefficient. Consider:
This chart shows the Fed assets in the top chart. Again the red vertical marks the week of QT confirmation. Since then, as the assets have declined, the USDOLLAR has appreciated. Furthermore, the correlation coefficient suggests a strong relationship, but this time it is inverse at -0.85. This reading makes sense. As the balance sheet shrinks, the money supply shrinks, which supports the greenback value. This tightening combines with Fed monetary policy to control inflation.
In addition, the dollar is considered a haven. In this light, the following factors are also supporting the USDOLLAR:
1. the eurozone is near recession;
1. geopolitics is still a concern (Ukraine and Taiwan);
1. Russia's economy is contracting rapidly,
1. China's economy is slowing; and
1. The UK's inflation just hit double digits.
Finally, the Fed's annual Jackson Hole symposium is this week. Fed chair Powell will likely push back against recent market loosening conditions, which may drive more haven demand.
Senior Market Specialist
Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.