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A Case for a Stronger Dollar in 2021

Posted: Tuesday, January 12th, 2021

Estimated Reading Time: 2 minutes

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A stronger dollar seems out of the question in 2021. Not even one investment house in the world believes that the dollar might strengthen this year. Such a mega-consensus typically leads to overexposure and huge positioning – factors that create volatility.

US Dollar Index

Why Should the Dollar Decline?

The arguments for a decline in the world’s reserve currency’s value are more than compelling. First, fiscal policy and inflation expectations point to a lower dollar. The new administration in Washington made it a priority to expand the fiscal stimulus in the first quarter of the year. Coupled with the Fed keeping the dollar swap lines open, we have the perfect storm for further declines.

Second, the so-called secular topping formation on the U.S. dollar index. The index, composed mainly of the EURUSD exchange rate, formed a double top pattern above 100. The target or measured move for such a pattern leads to the U.S. dollar index reaching 75.

In short, more money printing, ongoing U.S. money supply growth are factors to weigh on the dollar. Is it so simple?

A Stronger Dollar Ahead – Is That Impossible?

On the fiscal and monetary space, that is little that would support the case for a stronger dollar with one exception – tapering. I know it is early to even talk about tapering, but the risk here is that the Fed will taper the quantitative easing program earlier than other central banks. Only the thought of that happening is enough to send the dollar higher.

Moreover, the recent ISM data suggests a stronger dollar in the days ahead. According to Nordea, on average, the dollar strengthened in the first one hundred days following the ISM Manufacturing reaching the 60 mark.

Stronger Dollar

Finally, the double top on the U.S. dollar index is the easiest pattern to break. The risk at reversal pattern like a double or a triple top is that the market forms a continuation pattern. The technical analysis theory says that the double top shows the market hesitating against a horizontal area. More precisely, the market finds resistance.

However, the same happens during ascending triangles. At the early stages of an ascending triangle’s formation, the market forms (you guessed) a double top. Or, something that looks like a double top, only that in the end, instead of a sharp reversal, the market rallies.

Giving that all market participants expect a lower dollar, thus positioning accordingly, the risk is for a nasty U.S. dollar index return. If that is the case, the rally that leads to a stronger dollar should exceed the velocity of its 2020 decline.

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