The dollar has been “strong” for a long time. From a low of 89.75 in May 2021, the DXY rose to nearly 115 in September 2022, a surge of nearly 28% — around 80% of the rise came during the 12 months starting October 2021. After the pandemic hit in January 2020, the Fed brought down rates (from 1.5%) to near-zero by April to keep the economy from collapsing even further; with rates flat on their back, the economy began to slowly revive as had inflationary pressures, and by October 2021 the market had begun to worry that the ultra-low rates could trigger serious inflation, which might be difficult to control. The Fed took its time to decide — it was clearly behind the curve — and only started raising rates in March 2022, a full six months later. By this time prices were off to the races and the dollar took to the skies.
Interestingly, the DXY peaked while the Fed was still raising rates and, since September 2022, while rates were rising, the DXY actually started coming down quite sharply, and has remained in a range of around 100 to 106 since then. Clearly, markets are not an on-off switch, and even though Fed funds today (5.33) are much higher than they were in September 22 (3.08), the DXY is quite a bit lower.
To my mind, as much as rising rates, it was the fact that the volatility of DXY had fallen to a trough of 4.33% back in October 2021, which triggered the sharp move. Monitoring volatility is an important tool to try and assess turning points — of course, in truth nobody can ever, except by dumb luck, predict an exact turning point in any market.
Currently, volatility is again falling but, at 5.27%, it may be showing signs of another trough. If this is, indeed, confirmed over the next few weeks, we could see another turning point — this time in the direction of a lower DXY. Indeed, even if DXY volatility does not trough, we could see the dollar move lower — since it ain’t going up, it’s got to go somewhere. Biden’s sabre-rattling towards China, while clearly a political move to try and stymie Trump, could provide the fundamental focus for this kind of market action. Again, as the US election approaches, volatility in all markets (including the value of the dollar) should be the order of the day.
Non-USD exports should increase their hedge ratios.
This would form an interesting backdrop for the rupee, which is currently under a lot of pressure from uncertainty over our own elections. If, indeed, the dollar was to weaken and the Bharatiya Janata Party (BJP) returned to power with a majority, we could see the rupee breaking out upwards to 83 and, perhaps, even higher. We note that inflows in both equity and debt have turned strongly negative since April 1, more, in my view, because of pre-election jitters than the old saw of higher US interest rates, which appears to have played out, as explained above. If the mood turns positive, we could see much more than the nearly USD 5 billion that flowed out in a hurry.
If, again, the dollar was to weaken but the BJP failed to achieve a majority, we could see the rupee fall sharply to 84 and, perhaps, lower, as outflows would accelerate.
Having said that, however, we also note that inclusion in the JPMorgan bond index is scheduled to begin on June 28 — while there is no certainty that this date itself would trigger inflows, the reality is that debt outflows would likely moderate and, over subsequent months, we should see strong inflows, which should contain the intensity of any rupee fallout.
