Typically when a country raises interest rates, the national currency increases in value.
Higher rates attract marginally more foreign investment (i.e. increased demand), which is seeking improved return.
However, the absolute interest rate, and its level relative to peers, are some additional factors that affect the ultimate direction of a national currency.
The US Dollar, which is hovering near 15-month lows, has been challenged by some of those "other" factors so far in 2017.
And while there are many theories out there as to why the greenback has been weak, the reality is that some currency movements can’t be perfectly explained.
The dollar popped in the wake of Donald J Trump’s election to the White House, but has since faded along with much of the new President’s early momentum.
As noted earlier, rising interest rates in the United States should be a positive for the currency. The Federal Reserve has raised rates twice already in 2017, and has indicated that another hike may be in the cards before the end of the year. However, the US dollar has steadily decreased in value in the wake of those moves.
Confidence obviously plays a big role in the perceived value of a currency, and the fact that things aren't exactly going smoothly for President Trump early in his term helps explain at least a portion of the dollar's weakness.
Along those lines, the strengthening of the economy in the Eurozone, as well as many of the world's emerging markets, is pushing a lot of other currencies higher, in favor of the dollar.
As indicated on a recent episode of Closing the Gap: Futures Edition, the euro recently hit a 2.5 year high against the dollar, offering clear proof that the dollar is currently out of favor as compared to the euro.
Greece, which for many years has been closely tied with the term "financial crisis," had to turn away investors (i.e. oversubscribed) during a recent foray back into the international bond market. Another sign of just how far the confidence pendulum has swung.
It’s important to remember that valuing a currency depends on what you are comparing it against.
While the euro has been charging against the dollar, the British pound has gotten creamed versus the dollar over the last several years. The pound has gained a little ground back against the dollar in 2017, but only marginally as compared to the euro’s strength versus the dollar.
The pound obviously faces its own set of unique headwinds, as Britain moves closer to finally exiting the European Union.
For traders that think the dollar’s move lower is starting to get overdone, the guys on Closing the Gap: Futures Edition outline a potential trade using UUP (dollar index) and FXB (British pound).
On the show, the guys explain their outlook for both currencies, and why this particular structure helps them access the exposure they are seeking. The specific structure highlighted on this episode involves getting long UUP while simultaneously buying a put spread in FXB.
Obviously, traders could also express their bullish view on the US dollar by simply getting long UUP, without the FXB position.
We hope you’ll take the time to review the full episode of Closing the Gap to get updated on recent developments in the currency market when your schedule allows.
If you have any questions regarding potential currency trades or trends, we hope you’ll leave a comment below or reach out at firstname.lastname@example.org.
One final item to keep an eye on regarding the dollar is the potential repatriation of corporate dollars held abroad by a variety of US companies. If the Trump administration successfully negotiates a method for that money to return to the US, the US Dollar could experience a quick pop in value.
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.