The US currency represents one of the most widely used one concerning currency deals. Liquid currency pairs include:
- USD/JPY
- USD/CHF
- EUR/USD
- GBP/USD
As it can be seen the USD is part of all of these currency pairs, which are the ones most widely traded. This leads to the conclusion that developments and movements in the value of the USD should be closely watched in order to determine any changes that can result in a different currency position.
Before the terrorist attacks of September 11th occurred, the USD was regarded as one of the safest currencies. This was caused by the lack of any significant risk regarding the stability of the US dollar. This resulted in many foreign investments being attracted to the US, which were usually at a discounted rate of return.
Approximately 76% of global currency reserves were held in USD, which was also caused by its dominant factoring currency status.
However, the following terrorist attacks led to the loss of confidence in the USD. This resulted in foreign holders reducing the US assets they hold due to decreased interest rates and confidence in the USD.
The USD and gold are connected in an inverse way. This means that when the value of gold falls, the value of the USD increases. Since gold is measured in dollars, this inverse relationship has been created. Additionally, gold is regarded as the major store of value. However, the recent fall in the value of the USD has led to an increase in the value of gold.
Many countries with emerging economies tend to tie the value of their currency to that of the US dollar. This means that the central bank of the country has to keep its reserves in USD. The selling and buying of the domestic currency is done on a rate that is linked to the reserve currency. The amount the central bank has to hold on reserve should be at least equal to the amount of money that is in circulation within the country.
Different policies have been applied in order to keep the US dollar strong. In order to measure the strength of the US dollar it is useful to analyze the US Dollar Index. The latter is calculated through the trade-weighted geometric average of six currencies and is traded on the NY Board of Trade.
The value of the US dollar can be greatly influenced by the health of the equity and fixed income markets. So, if the conditions on the equity market are not good, investment opportunities from abroad will be looked for. On the other hand, if the condition of the equity market is good, so is the value of the dollar since more investment opportunities are offered.
Foreign investments are generally attracted by valuable fixed income opportunities and high yields.
In order to identify any future movements in the currency, you should watch the rate differentials between the US treasuries and foreign bonds. The major reason for the importance of these indicators is that generally investors search for assets that tend to enjoy high yields. Investors tend to sell their US assets and direct their resources to foreign ones when the yields in the United States fall or foreign assets’ yields increase. This will lead to the selling of the USD in order to acquire more of the foreign currency.
Alternatively, if yields in the US increase or they decrease abroad, investors will strive to purchase more of the US assets, which will lead to increase in the value of the US dollar.
