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The Dollar Index (DXY) – and Nifty!

In the recent few days, Nifty has been climbing new highs even as doomsayers had written off any recovery in CY20. Call it sentiment or call it irrational optimism- the fact is that the markets were telling us something since the middle of the year – and the largest such hint was in the DXY. And that’s where the future secrets lie as well! Its important for market observers to be focused on this index as it’s the best harbinger of trends to follow!

The DXY

The ICE U.S. Dollar Index ((Watch DXY live at https://www.bloomberg.com/quote/DXY:CUR) is the barometer of strength of the US Dollar and therefore indirectly a measure of global risk appetite. The index measures the USD strength by using a weighted average of currency six currencies vs USD

In the previous week, and after hitting highs of 100 earlier, the index slumped to a low of to 89.7, trading below 90 for the first time since April 2018. It’s down 6.8% so far this year. This sharp fall in the previous week had given momentum to equities globally as they struggled to maintain new highs. A falling dollar is typically seen as a positive for global equities as well as the world economy. It’s also seen as the potential missing ingredient for a bullish turnabout in commodities priced in the dollar.

The index has dropped nearly 13% since March, when it spiked to a more-than-three-year high as the COVID-19 pandemic plunged the U.S. economy into recession and sparked a bout of chaos in financial markets, driving global investors into the safety of the world’s reserve currency. And that’s there we have had our bull run!

Riskier assets like global equity indices along with commodities like base metals and crude oil continue to hit fresh multi-month peaks while even safe havens like gold and silver, which had noted sharp correction last month, seem to be retracting their decline.

Forecasts

The DXY has recovered in the last couple of days and is now at a major level of around 90 – a make or break level! The recovery has been sudden and caused by concerns over a new type of coronavirus strain, which is reportedly 70% more transmissible than the original. This is supportive of USD strength.

The longer term trendlines on the USD still indicate it will fall below 90. The sentiment is already very weak and the consensus is very negative. The recent Fed actions, which vowed not to touch monetary policy even if the outlook for the U.S. economy brightens is what could be contributing to the underlying weakness in trends.

Summary

The US and emerging markets alternate in leadership over long cycles with the direction of the dollar being important in the shorter term as a measure of risk aversion while superior growth helps EM long term with its growth alpha. The decade long outperformance of the US over emerging markets may be coming to an end – and so may be the DXY – Emerging markets value and small cap stocks are now the cheapest asset class in the world while US Large Caps are the most expensive. Both are therefore priced for reversal if the right conditions persist. As of now the Emerging Markets are also poised critically (chart below) as they attempt to break out of the Bollinger Bands! The dollar holds key – as these are levels from where reversals are often swift.

How and when this unfolds is now heavily centered around what is happening to underlying growth, the spread of the virus and the relatively friendlier global trade regime with Brexit talks and Biden gestures. Or instead of poring over newspapers for hours, just keep an eye on the DXY as it captures it all.

Nifty at current levels of 13000 odd are not at highs – they are at levels where (short term corrections notwithstanding) history will start getting made!

The next decade beckons!

CO – EDITOR: VIKRAM KASAT, HEAD – ADVISORY AND WESTERN REGION , PRABHUDAS LILLADHER

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