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Will the Overbought US Dollar Weaken?

Adam Lienhard

Recently, the US dollar has experienced a noticeable increase in value. Some may argue that it is currently overvalued and stretched and could weaken to recent lows. Still, it could receive support from the Fed’s potential interest rate hikes soon. Technically, the Dollar is overbought but a pullback below key levels could be difficult without a catalyst.

The highs of the US dollar

The recent surge in the value of the dollar can be attributed to its perceived safety during the COVID-19 crisis. Increasing trade and political tensions between the United States and China also contribute to the appreciation of the USD. 

However, when the global economy stabilizes, the dollar’s appeal as a store of value may decline. In the long term, the dollar’s weakness is evident due to the widening of the current account deficit and the US budget, which have increased significantly due to the pandemic’s economic fallout.

Will it decline?

There are signs that the dollar may experience a decline in the future. One of these factors is the Dollar Index, which has risen by 3.4% since early May. It indicates a buying trigger and a correction. 

Officials from the Treasury and Federal Reserve have expressed concern over the rapid rise of the dollar and the accumulation of excessive amounts. They are suggesting that the rally may not be sustainable. 

The United States’ economic recovery has been slower than expected, with high unemployment and a significant contraction in GDP. If the Federal Reserve keeps interest rates low for an extended period and seeks more stimulus, it could further weaken the dollar’s appeal to investors seeking returns. However, the highly anticipated rate hike by the Fed may temporarily boost the dollar by attracting capital inflows.

World’s reaction to the trend

Other major central banks are also implementing stimulus measures and ultra-low rates. This could limit the dollar’s growth. The European Central Bank, Bank of Japan, and Bank of England have all indicated their intention to continue with stimulus programs for an extended period.

If the recovery of the US economy remains weaker than that of Europe and China, it may cause a rise in demand for currency competitors such as the euro and yuan. Reports from the Organization for Economic Co-operation and Development suggest that the US economy will experience a relatively shallow recovery this year.

The demand for safe-haven assets, reflected in the sharp rise in gold prices in 2020, indicates that the dollar’s appeal as a store of value may be limited, even with an eventual Fed rate hike.

Geopolitical risks between the US and China show no signs of abating. The ongoing deterioration of relations could negatively impact growth expectations and US Treasury yields and affect the demand for the safe-haven dollar.

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