USD forecast: why is the dollar the world’s currency?
13:41, 24 June 2020
The US dollar forecast has been dominated by global risk sentiment since mid-March when the extent that the coronavirus would impact the world economy became evident.
Effectively functioning as the global reserve currency since the end of the gold standard in 1971, the US dollar is viewed as a safe haven in times of uncertainty and tends to increase and decrease in value depending on investor risk-sentiment towards other alternatives.
Let’s find out why the US dollar is so strong right now, while some of the other major currencies are plummeting.
USD forecast: is a crash possible in 2020?
The US dollar trend in 2020 has experienced volatility not seen in almost a decade as the coronavirus continues to wreak havoc on the global economies.
This has led many to ask, can the dollar crash in 2020 and why is the dollar the world’s currency? As the US continues to introduce gigantic stimulus packages to decrease the negative impacts of shutdowns and unemployment, the national debt is poised to exceed $25 trillion and total more than 100 per cent of GDP by the end of the year.
United States dollar sceptics point to these facts as proof for their doom-laden dollar prediction. In order for there to be even theoretically a shift away from the US dollar there would need to be an alternative option. Below is a list of the most likely replacements put forward by those who believe this shift is inevitable:
- Euro – The euro is the second most widely used currency in Forex transactions and central bank currency holdings. While it may be second, it is a very distant second. There are also political stability concerns following the decision by the UK to leave the European Union as well as the vastly differing economic statuses between member countries.
- Chinese Renminbi – While China has become a major economic powerhouse and represents the second largest economy behind the US, the currency is subject to government controls and represents less than 2 per cent of central bank holdings across the globe. There may be some case for a gradual shift towards the Renminbi but any shift in the status of the US dollar is a long way off.
- Crypto – While cryptocurrency has certainly gained a huge following among traders it is for the very reasons that make it attractive that it is unlikely to replace the US dollar any time soon: mainly volatility. The value of Bitcoin can change dramatically in a matter of minutes and this would wreak havoc on global commerce. It is for this reason, among others, that while it has definitely gained popularity among traders it has failed to become widely used in day-to-day commerce.
While these questions may continue and there may well come time when another currency functioning as the reserve could become a reality, the potential of this happening in 2020 is minimal at best.
There are many reasons why the US dollar will remain the global reserve currency for the foreseeable future. At present over 90 per cent of foreign exchanges involve the US dollar. World oil, gold and other commodities are quoted in US dollars and the US is the largest economy in the world and is considered to be relatively stable both politically and economically.
The most important reason why the US dollar will remain at the pinnacle for the time being is that over 60 per cent of the foreign holding of the world’s central banks are denominated in US dollars and any shift to an alternative currency would be devastating not only for the US but the majority of other countries as well.
Many of the world’s economies are hugely impacted by the USD forecast. These are the main reasons why the dollar is the global currency.
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How to trade the US dollar?
There are multiple currency pairs which you can trade that are based in US dollars. These pairs can experience volatility and fluctuate because of factors affecting both currencies.
A more balanced option for trading on US dollar predictions is to utilise the US dollar index (DXY). The DXY is an index that represents the value of the US dollar relative to a basket of other currencies, thus decreasing potential volatility caused by a single other currency. The six currencies included in the basket and their corresponding weights are:
As you can see the euro represents the majority of the basket, owing to the fact that it is the second most frequently traded currency after the USD.
The inclusion of the other currencies is meant to represent the major trading partners of the US and decrease the potential for major swings in price. There has been discussion surrounding the makeup of the other currencies and the fact that China, Mexico, South Korea and Brazil are also major trading partners but not included.
As of the time of writing there is no indication that the weights or composition of the index will change in the near future. The index started with a value of 100.00 and has traded within a range of 94.65-102.99 in the past 52 weeks. The index is currently down -5.34 per cent over a three-month period but up +1.08 per cent from a year ago.
The index dropped dramatically at the beginning of the lockdown in the US before rebounding sharply as investors looked for a safe haven. It has since levelled out and the dollar outlook is trending upwards.
US Dollar: buy or sell?
The main question is, will the dollar go up again? The American dollar forecast has proven to be quite volatile in the short term as investors react quickly to any news surrounding government stimulus and any indication on the success of reopening the world’s largest economy following the pandemic.
In the current climate it is best to look at mid to long-term US dollar predictions and this is where the DXY can be very useful.
At the current spot rate of 97.01 the DXY is in-line with pre-pandemic January rates and is exhibiting an upward trend. The DXY is indicating a “buy” signal in the medium to long term. The current rate is a good entry point and provides for a reasonably safe stop loss point of 94, just below the low of mid-March, while providing significant upward room from highs of almost 104 reached in the rebound of late March.
Let’s take a closer look at our detailed USD forecast and dissection of the current DXY chart. Here is a short video by Capital.com market strategist David Jones.
As the world eases in to reopening following coronavirus there are likely to be periods of risk-off sentiment by investors which will provide opportunity for the dollar to increase.
Increasing volatility in the euro due to Brexit and in other currencies due to increasing debt service levels should make the dollar the obvious choice for global transactions and investors, at least for 2020.
Read more: USD/CNH forecast: is it time to invest in the US dollar vs Chinese yuan pair?
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