EUR/USD: demand for dollars is back in fashion

In a week when Fed Chairman Powell is about to make several speeches, the USD appears to be back in fashion as traders seek protection in the global reserve currency.

The recent stock market decline suggests that liquidity constraints remain and that U.S. Treasury stocks are still important.

U.S. Treasury creates a liquidity buffer

Catching many traders off guard, the U.S. Treasury issued more debt than the Fed issued new capital.

The recovery of the stock markets after the fall in March of 2020 was mainly attributed to the Fed's opening of USD swap lines. Once USD liquidity increased, the markets calmed down and a smooth recovery began.

At the same time, however, the US Treasury issued debt securities at a faster pace. It has even built up a liquidity reserve recently. The calculation of this process (i.e. more debt issuance than Fed asset purchases) leads to a net decrease in USD liquidity. This is one of the reasons why the stock market sold off last week and seems fragile now (U.S. futures suggest another weak start).

For traders, the DXY (dollar index) is the barometer or benchmark. It turns out that the liquidity conditions of the USD lead to changes in the DXY index of up to two months. In other words, the summer months should see a drop in the DXY, judging from the Fed's actions in the previous 2 months, while subsequently reversing itself, judging from the U.S. Treasury's actions.

As always, the calculation is tricky. It should happen, assuming that the Fed and the U.S. Treasury do not change anything in the meantime - which is unlikely, given the severity of the current economic recessions.

As a result, it is likely that both the Fed and the US Treasury will remain active players in the international financial markets, struggling to mitigate the negative impact of the virus situation.