The Dollar Super Cycle is not a dogmatic theory. It is based on logical patterns that every market participant can study. When looking at a national currency, an analyst can examine it in two different ways. The first way of analysing it is by measuring the exchange rate and the other way is by measuring the interest rate.
The ratio of these indicators has a non-linear dependence. World experts are still working on finding any relationship between these values, but it is not linear. As a rule, there is a cyclic movement on the price chart. The study of EUR/USD showed that the American dollar has gone through 4 cycles in 35 years (before the euro appeared, the German mark was used).
By studying cyclical processes, a trader will significantly increase the accuracy of long-term forecasts. He can rely on historical data and accompanying fundamental factors that allow him to predict the direction of exchange rates.
What is a super-cycle of the dollar? How does it appear?
At first glance, the dollar super-cycle is a very simple model. It includes two variables: the dynamics of Euro-dollar quotations and the short-term differential of US discount rates with the European Union. The second variable is the difference between the three-month Libor rate and the three-month Eurodollars futures contract, Euribor. Depending on the combination of these variables, economists distinguish several phases.
With the EUR/USD pair, scientists have managed to create a stable economic model that allows for competent fundamental analysis. The American dollar and the European euro play an important role in the world system, thanks to which they can be taken as the basis for a full-fledged analytical study.
To understand the essence of cyclical changes in market rates, a trader can review historical data. At the beginning of the 21st century, the Federal Reserve reduces the discount rate, after which short-term interest in the United States fell below European levels. As a result of this change, the U.S. dollar began a sharp decline. At the time, most experts believed that the reason for the significant drop was due to market panic. Concerns about the current account deficit were growing on the international scene.
In the summer of 2004, the US Federal Reserve began to tighten its monetary policy. At the same time, the dollar continued its downward movement. This situation is typical for the first phase. At the beginning of 2005, the US currency began to show growth, forming an uptrend on the price chart. This trend was maintained throughout the year. At this time, the differential was increasing in favour of US rates. The financial instrument moved into the second phase.
The last phase of cyclical growth of the US dollar began when the interest rate differential changed in favour of the European currency. It happened in the middle of 2005, when European futures reached their maximum mark. Specialists predicted an increase in the ECB rate, but at the end of January the spread began to widen again. Forecasts about tightening of the Fed’s monetary policy emerged on the market and by the middle of the month the spread broke through the August record of 220 points. Thus, the temporary narrowing of the spread turned out to be a corrective movement against the main trend.
At the moment, the US is experiencing a cycle of interest rate tightening. Some economists predict the end of this phase soon, but the excitement after several natural disasters is not in a hurry to subside. Experienced analysts believe that the Fed’s credit policy will depend on other macroeconomic indicators. In particular, it is recommended to monitor the level of GDP, its growth or decline.
The main phases of the dollar super-cycle
The phases are formed based on the correlation of several indicators: the dynamic change of EUR/USD quotes and the short-term differential of US rates with the EU. The dollar super-cycle envisages 4 phases:
- In the first phase, rate indicators work in favour of the US currency. At this time, the quoted value of the monetary unit falls. The purchasing power of money decreases and citizens are forced to pay more for familiar goods.
- In the second stage, discount rates continue to increase, but now the dollar shows rapid growth. The economic situation in the country improves, people become more wealthy and can afford more purchases.
- At the third stage, the value of the differential shifts in favour of the European currency. At the same time, the position of the ‘American’ continues to strengthen by inertia.
- At the fourth stage, the US dollar begins to decline with the differential unchanged.
Taking into account the super-cycle of the dollar, the phases can be viewed in a historical context. By tracing past occurrences, a trader will draw valuable conclusions and make a quality forecast of price movement. In addition to interest rate differentials, an investor should take into account other fundamental factors. He is advised to monitor GDP figures, unemployment rate and general market sentiment. High-profile news and significant events in the political arena will have a strong influence on the quotes, changing their value.
