Earlier in the week, the U.S. Federal Reserve gave the dollar a boost when its FOMC minutes indicated to market participants that is was not planning to implement any additional stimulus to boost the U.S. economy. This provided traders with confirmation that every major central bank was easing with the exception of the U.S. Federal Reserve.
Equity and commodity markets had been trading close to their near-term highs in anticipation of better news, but once the minutes were released, investors were encouraged to lighten up on their long positions in higher risk equities and commodities.
Since the Fed meets on July 31 and August 1, investors are encouraged to pay close attention over the next two weeks to economic reports since this same information will be used by the FOMC members to make their next decision on additional stimulus. Any shift in direction will be in keeping with the Fed’s statement to stand ready to provide additional stimulus when necessary.
In the meantime, traders should be aware of the effect the stronger dollar has on currencies, equities and commodities. Interest rates ultimately drive all markets so when one central bank is raising rates and another is holding rates steady or easing, money will flow into the currency offering the better rate of return. In other words, money will seek the highest level of return.
This explains why traders are favoring the U.S. Dollar over the Euro and the British Pound for example. As for its effect on commodity prices, commodity markets priced in dollars get more expensive when the dollar rises. Higher prices will often lead to lower demand so demand sensitive markets like crude oil typically go down in value.
Gold will also usually lose value when the dollar rises. This is based on the theory that investors want to hold paper or hard assets. This is pretty close to the theory that investors buy or sell close based on the inflation outlook for an economy. For a prolonged period of time while inflation has been under control according to the Fed, investors have been treating gold as both a reserve currency and an investment.
Those looking at gold as a reserve currency typically sell it when the dollar rises. Those investing in gold to generate a positive return will buy it when it gets relatively cheap and sell it when it is expensive.
The following charts will demonstrate the U.S. Dollar’s influence on a few related markets.
The U.S. Dollar resumed its uptrend this week when it took out the June 1, 2012 top at 83.54. This move solidified a new bottom at 81.19. As long as this higher-top, higher-bottom trading continues to take place, investors should look for more upside movement.