How to Trade the Dollar Weakness – Introduction
The United States dollar has had a difficult time this year. The dollar index which tracks the dollar against major currencies has lost about 9% of its value. It has however gained some points in the past few months with hopes of a new federal reserve chair and hopes for a tax reform. Even if a new hawkish chair is named and a tax reform proposal is passed, hopes of a bull run in the dollar might be slim.
The dollar has weakened because of several factors. First, the economies of other countries that constitute the dollar index have strengthened. The Euro, which has been a drag for years has performed well with the improving European economies. The only drag has been the British pound which continues to suffer from the uncertainties of the Brexit. Secondly, the new American president favors a weaker dollar as a way of helping bridge America’s trade deficit which continues to increase.
The financial market is always cyclical. All assets undergo the process of weakness and strength all the time. For example, the energy sector which saw big declines last year are on a path to recovery. Equally, the Euro which has struggled in the past three years is doing well. However, analysts and traders should understand that for the dollar, this time is different, and it might not recover fully as it has always does.
First, with the new American protectionist agenda, the world realizes that it cannot depend on America fully. In fact, this year, America’s view from overseas has plummeted. This opening has led to a new world order where China is now very powerful. In fact, last month’s edition of Economist named the Chinese president the most powerful person on earth.
China is now slowly taking the place America used to have. In this line, China has asked its oil suppliers like Russia and Saudi Arabia to ditch the dollar and use the Yuan to trade oil. If this plays out and is replicated in other oil countries, chances are that the American dollar will be under pressure.
Further, in the short term, the demand for oil is expected to rise but in the long term, things will change as countries adopt to the electric vehicle revolution. In the next few years, it is estimated that electric car sales will overtake combustion-based cars. China, European Union, and other countries like Norway have resolved to end selling of combustion cars.
Therefore, as demand for oil reduces, and as countries move from the dollar to the Yuan, the demand of the dollar could plummet.
A weaker dollar is not necessarily bad. In fact, a weak dollar opens trading opportunities to many American stocks.
If you have read or listened to American companies conference calls, you know that currency fluctuation is one of the major excuses CEOs make for underperformance. This is especially often to the multinationals like P&G which make most of their money from overseas. They blame currency when the dollar is strong.
A weak dollar helps companies like these multinationals because it helps them sell their products at affordable prices. Companies that comes to mind in this are companies like Boeing, Proctor & Gamble, Lockheed Martin, and General Electric among others.
Another way to trade a weak dollar is to trade its correlation with other assets. For example, I have written several times about the inverse relationship that exists between gold and the dollar. Often, gold strengthens when the dollar weakens. This year, while the dollar has lost about 9%, gold has gained by 11% and I believe it could be more if not for the cryptocurrencies. Therefore, if you are a long-only trader, you can comfortably invest in assets like gold and silver that do well when the dollar is weak.