To The Moon

In the recent two weeks, we have discussed the 2022 trends of U.S. stocks and commodities, and today we‘d like to bring some analysis of expectations for the US dollar in 2022.

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The U.S. dollar index closed at 95.5916 on Dec. 31, 2021, up 6.2% y-o-y.Looking at 2021 as a whole, the US dollar will strengthen against both low-yielding currencies (EUR, JPY, CHF) and high beta currencies (AUD, NZD, NOK), leading the G10 currencies in 2021.

According to the above chart, the trend of the US dollar index can be roughly divided into three period in 2011:

First question: In a rate hike environment? Does the dollar Index continue to rise for sure?

According to the analysis by historical review, the Fed's interest rate hikes are not necessarily accompanied by a strengthening of the US dollar index.

The review of FED's two interest rate hike cycles in 2004 and 2015 shows: Only when the US recovery is stronger than non-US countries leads to a clear policy divergence between the Fed and non-US central banks is the key factor for the strengthening of the US index.

Here are details from two previous rate hike cycles:

• Rate hike cycles since 2004

After the burst of the Internet bubble in 2002, the U.S. economy gradually recovered. The FED started a cycle of interest rate hikes in 2004, while the non-U.S. countries were not greatly affected at that time. The U.K. and Australia raised interest rates earlier than the U.S. and to a greater degree, attracting capital inflows.  Therefore, The FED's rate hike did not save the dollar's weakness.

Until 2005, the FED continued to raise interest rates by 2%. At the same time, the US Senate and House of Representatives passed the "Local Investment Act" in October 2004, which lowered the income tax rate for US companies' overseas earnings from 35% to 5.25%, which led to the return of the US dollar. These two factors made the US dollar index temporarily stronger.

• Rate hike cycles since 2015

After the 2008 financial crisis, the FED started a cycle of interest rate hikes at the end of 2015. While in this cycle, the Euro area was deeply mired in the European debt crisis. The Bank of England, the Reserve Bank of Australia, and the Bank of Canada all chose to do nothing or even reduce interest rates slightly.

So the comparative advantage in US interest rate spreads has been highlighted. Even after a brief decline the U.S. dollar index rose again hitting a high of 103.80. in 2021.

Another Question: Will the dollar index continue to rally in 2022?

Institutional insights highlight: Morgan Stanley, Sumitomo Mitsui Trust Asset Management, Lombard Odier had forecast a stronger dollar trend in 2022, but analysts warned that the dollar's gains will moderate. That's because the market has priced in the FED's policy and future expectations.

Cite from Forbes

In addition, below are four factors that will affect the US dollar's trend in 2022:

• First, because the current FED's pending policy decision for a rate hike was behind other countries (United Kingdom, New Zealand, etc ), in addition, the magnitude of the rate hike will not be as strong as that in Canada or Australia, which will lower the attraction of the U.S. dollar.

• Second, U.S. inflation will remain at a high level but will fall. The FED deleted the expression "transient inflation" at the December FOMC meeting, which indicated they clearly acknowledged that inflation may remain high for some time. Even though the previous CPI index was strongly influenced by future demand that was pulled forward, the growth in the CPI index may be difficult to sustain as the key driving factors from energy, the used car market, and housing markets will decline. If inflation decelerates in 2022, some members of the FED may be patient in raising interest rates, which is very likely to be negative for the dollar.

• Third, the market has priced in the FED's tightening monetary policy, and the future growth of the US dollar index may be limited. The FED has made it clear that it will end its asset purchase program in March 2022 and then prepare for its first rate hike since the start of the pandemic. Most Fed officials expect three rate hikes in 2022. Rising interest rates will push up U.S. funding costs and tighten financial conditions, affecting the recovery of interest-rate-sensitive industries such as automobiles and housing, thereby limiting the strength of the economic expansion, while influencing the Dollar index increases.

• Finally, The impact of fiscal stimulus in 2022 may be weaker than in 2021, and the economy may decline and not be good for the dollar to rise strongly. Biden’s approval rating has been declining since August 2021. The original $3.5 trillion fiscal stimulus plan was cut to $1.75 trillion, a 50% reduction, and the probability of launching a large-scale fiscal stimulus in 2022 is unlikely. Expectations that fiscal-driven U.S. economic growth will fade may cause U.S. economic growth to decline next year. Considering that residents have a certain willingness to save preventively under the pandemic, consumer spending in the US may further weaken marginally, or the overall economy may decline to a certain extent, and the recovery performance may not be enough to support the strong rise of the dollar.

So the conclusion is as follows:

Due to this round of interest rate hike cycles, major developed countries have strong economic synchronization. The United States lacks the ability to drive growth for the rest of the world, and the market has basically priced in that inflation will peak and fall next year. At the same time, in this round of interest rate hike cycles, the effectiveness of the FED's communication with the market has been enhanced, and the market has already priced in subsequent interest rate hike expectations to a certain extent.

We expect the dollar index to rise first and then fall in 2022; Under this environment, the market’s liquidity is still relatively sufficient. Under a normal interest rate environment, stocks, cryptocurrencies, or other risky assets are still a choice for diversification.

Let‘s take a close look at whether the rate hike expectations will increase after the first rate hike in 2022. If not, the US Dollar Index will decrease.

Final Question For You！

What's your expected fluctuation range for US Dollar in 2022?

Do you think stocks and Cryptos are the best risk assets to invest in 2022?