The fall in the USD explained

FX Strategy Articles > Fundamental articles

In recent times, the USD has been sold off against all major cross currencies. This article looks at why the USD has performed so badly and looks at the future of the USD.

The reason why the USD has suffered so badly is that interest rates in the U.S remain at near record lows. When interest rates are low the demand for a currency drops as investors can yield higher returns by holding other currencies that generate higher interest payments. The chart below graphically illustrates the dire state of U.S interest rates showing them to be near zero.

So why are U.S interest rates so low?

The U.S economy has hit rocky times over the last 10 years being hit particularly hard by a recession in 2001 and the global financial crisis towards the end of last decade. Indeed the U.S economy has seen record levels of unemployment, billions wiped off the financial market and a deficit which is more than 14 trillion dollars. To put this into perspective, each citizens share of the debt is approximately $45,000.

In order to stimulate an economy, policy makers endeavour to keep interest rates low. Low interest rates encourage investment, as repayments for loans are low, which in turn helps stimulates an economy. Only when an economy begins to grow, and inflation becomes an issue, do interest rates go up. The chart below shows the steep decline against two of the major cross currencies since January (the CAD and the CHF). The trend is similar against all cross currencies.

What is the future for the USD?

As you have probably gathered by now, the future of the USD depends on how the economy, and in turn interest rates, change over the next 12 months and beyond. Historically, the best guide on the future of interest rates is to look at the yield on long term government bonds. The yield on these instruments takes into account the economies expectations on the future direction of interest rates and by proxy the economy itself.

The table above shows the yield on U.S treasure bonds for the next 30 years. As you can see, the outlook remains pessimistic, with the 2 year yield remaining below 1 per cent. After 5 years, the yield is still below 2.25 per cent. I doesn’t take a genius to work out that the road to recovery in the U.S is going to be slow and this is reflected in the bond yields below. The wash-up of this, is that traders should not expect a fast recovery of the USD vs cross currencies based on fundamental data.

Published on 12th of April 2011
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