Long before the Federal Reserve made its first decision to raise interest rates in March, the dollar was experiencing dynamic growth. In July 2021, the dollar index was trading at a low of 89.45, and in just over a year, it has risen to a 20-year high above 110.
When analysts talk about the strength of the dollar, it is a little misleading at first glance. In terms of its purchasing power, the dollar has lost value and continues to lose it. With inflation above 8%, the cost of goods and services still means the US dollar has less purchasing power than it did a year ago, five years ago, or 20 years ago.
The strength of the dollar index represents the dollar against a basket of six currencies it is linked to. In this basket of foreign currencies, some of them carry more weight. The Eurodollar, for example, stands at 56.7%, which is the largest component of the index. The Japanese yen has a weight of 13.6%, the British pound 11.9%, the Canadian dollar 9.1%, the Swedish krona 4.2%, and the Swiss franc 3.6%.
Since the vast majority of countries devalue their fiat currency, creating an excess money supply, the dollar depreciates less than other currencies to which it is pegged. Thus, using the term "dollar strength" is just a measurement of the value of the US dollar in foreign currency compared to the foreign currencies contained in the dollar index.
As yields on US debt instruments, such as 30-year Treasury bonds or 10-year Treasury bonds, rise, the by-product is a rise in the dollar index. This is exactly what we are seeing as the Federal Reserve aggressively raises rates.
Today's high of 110.71 is the highest level of the dollar index in 20 years. From a technical standpoint, there are no strong resistance areas between 110 and 120, which are the highs the dollar hit in 2001.
At some point, the dollar will recover, but as long as the Federal Reserve continues to raise interest rates, US debt yields will rise. Higher yields will certainly continue to provide strong support for the dollar.
