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#1 04-02-2021 09:30:37

johnedward
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From: Paris - France
Registered: 21-12-2009
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EUR/USD: why is the dollar higher when the market is short?

EUR/USD: why is the dollar higher when the market is short?


One of the main lessons in 2020 was that the falling dollar has helped the world fight the virus situation. Indeed, this was the case, especially after the Fed in the United States opened USD swap lines with other major central banks around the world.

Towards the end of 2020, all the world's major investment banks predicted a rise in equity markets due to the falling dollar this year. Various arguments have been put forward to justify the so-called reflationary trade, all of which are valid.

If one moves forward quickly by one month into the new trading year, the dollar is stronger, not weaker. The EUR/USD pair is struggling to hold at 1.20 after trading above 1.2330 at the beginning of the year. This represents a drop of more than "three big numbers" in less than a month, as traders like to say.

The Fed is not as aggressive as it appears to be

The starting point for understanding the dollar's rise is the Fed's balance sheet. While the Fed has effectively expanded its balance sheet last year by re-engaging in quantitative easing, other central banks have been more aggressive.

For example, the Swiss National Bank (SNB) has a balance sheet of 140% of its gross domestic product (GDP). The same applies to the Bank of Japan (BOJ). Even the balance sheet of the European Central Bank (ECB) has expanded to almost 100% of the eurozone's GDP and is still growing. What about the Fed? The expansion of the Fed's balance sheet barely reached nearly 60%, which explains, although partially, the strengthening of the dollar at the beginning of the year. In other words, other central banks have relaxed more than the Fed. This therefore favours a stronger dollar.

Another element to take into account is the new US Treasury Secretary, Janet Yellen. When she headed the Fed a few years ago, she was hawkish about the role of the dollar in the international financial system.

Just after she took over as head of the Treasury, the market learned this week that the Treasury Department was massively reducing its issuance plans in the first quarter of the year. The goal is to reduce the Treasury's general account balances by more than two-thirds. This will have the side effect of increasing the reserves of the banking system and the initial effect should be dovish for the greenback.

However, on closer inspection, by cutting emissions, the Fed will not have enough to buy to continue to grow the balance sheet at a faster pace than its rivals. Therefore, a stronger dollar makes sense.

If we don't see any change in recent trends, the danger is that the dollar rally will intensify as the market is positioned on the other side.

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