The U.S. Dollar is the most traded currency in the world with more than US$2.9 trillion traded every single day. Almost all other currencies in the world are measured against the U.S. Dollar. As USD strengthens against INR, the value of INR falls; which means that for every dollar you buy in the market, you pay more and more INR.
Recently, after a long rally, the DXY, which is the U.S. Dollar index, fell by almost 11% in a matter of 4 months. This is huge news, not only for forex traders but also for investors like you and me. In this article, we’re going to explore what made the dollar weaken in the past year, and how it can benefit your investments.
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Understanding the DXY
The DXY, or the U.S. Dollar Index, is a measure of the value of the United States dollar relative to a basket of foreign currencies. This basket includes the euro, the Japanese yen, the British pound, the Swiss franc, the Canadian dollar, the Australian dollar, the Chinese yuan, and the Mexican peso. This means that if the DXY falls, these currencies appreciate in value automatically.
Recently, after a huge rally, the dollar has been weakening against these currencies. This drop is astronomical, especially when considering the tiny time frame. This depreciation has been attributed to a combination of factors including expectations of a slowing US economy and a potential pivot by the Federal Reserve towards a less aggressive monetary tightening stance. In the long term, this has far-reaching implications for the USD and the world economy.
Why has the dollar fallen?
Experts attribute the fall to a number of factors.
The U.S. fiscal deficit
Two months ago, the United States government posted a budget deficit of more than $1.6 trillion, a 23% jump from last year. A deficit is the difference between the revenues of the government and its expenditures. Such a large fiscal deficit signals that the United States economy has to issue more and more debt in the form of bonds to fund its working, which will push prices down and yields back up.
The deficit is also so large, in part, due to the country’s war efforts in both Ukraine and Israel. The Biden government recently asked for an additional $100 billion in new foreign aid and security spending, including $60 billion for Ukraine and $14 billion for Israel, along with funding for U.S. border security and the Indo-Pacific region.
Jobs and unemployment
As the Fed has increased rates to astronomical numbers in the past weeks, inflation has gone down, but so has employment. While non-farm jobs increased by 150,000 jobs as per the latest data, the number is much lower than expected – especially when accounting for the number of jobs the country needs to create to keep up with rising prices and population growth.
Bond rate expectations
The Fed uses interest rates to control inflation in the economy, but with higher rates also comes economic slowdown. While the recent rate hike and inflation numbers show that the economy is headed for a ‘soft landing’ in the future, the dollar index signals that activity is actually starting to show signs of slowdown.
Fed Governor Christopher Waller flagged a possible rate cut in the months ahead. “If the decline in inflation continues for several more months … three months, four months, five months … we could start lowering the policy rate just because inflation is lower,” he said. With lower yield rates, the dollar goes down against other currencies due to less demand. These policy expectations could also be a cause for increased shorting in DXY futures, which are expected to fall when rates are cut eventually.
What does this mean for Indian investors?
Global currency markets, and to a large extent, equity markets are interconnected. This is especially true in the case of changes in the U.S. economy. While rate cuts or hikes from the Fed don’t directly affect policy changes in India, they certainly do have some impacts. Here are some of them:
- More Foreign Institutional Investment (FII): A weaker dollar makes Indian stocks more attractive to foreign investors, as their dollar-denominated investments can earn higher returns when converted back to their home currencies. Foreign capital, which is almost always voluminous, is enough to boost stock prices and overall market liquidity.
- Better export competitiveness and cheaper imports: Indian exporters can benefit from a weaker dollar, since a weaker dollar essentially means stronger INR. As their products become more affordable for overseas buyers, volumes can increase, which in turn lead to more revenues and earnings. The inverse is true for imports – as the dollar becomes cheaper, overseas imports (which are almost always dollar-denominated) become cheaper for importers.
- Cheaper foreign debt: Since a weakening dollar often leads to a stronger Indian rupee, which can make it cheaper for Indian companies to service dollar-denominated debt. This can improve their financial stability and reduce their risk profile, and corporate interest rates become more competitive.
- Rupee investments become more attractive: A weaker dollar can make rupee-denominated assets, such as Indian bonds and real estate, more attractive to domestic investors. This can divert investment away from dollar-denominated assets and support the growth of the Indian economy.
Although financial markets are much more complicated and almost never operate in a straightforward manner, a weakening dollar does generally mean good things for INR investors in the country.