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Financial conditions and interest rate differential have been the main reasons that have determined the U.S. Dollar strength, although the variables to consider and factorise to understand the reasons for the DXY strength can describe the many layers of complexity and moving parts in the markets that can determine currency strength. When pulling up the USDollar exchange rate the immediate point of reference that any asset manager will have in mind are the United States twin deficits, the Fiscal Deficit and the well-established Balance of Trade for Goods deficit, as the United States economy has been a longstanding net importer of goods in what has been defined for simplicity the Global Economy. The strength in growth of the United States economy has been derived simply from the ability to enhance Fiscal Deficits, the chart below highlights the consistent path of Fiscal Budget deficit in the past 25 years

While also important to the Global Economy, it has been the United States Balance of Trade deficit, that makes the American economy a Net Importer of Goods from other Countries, this dynamic determines the flow of goods and savings from Exporting countries to the U.S. economy while allowing the U.S. Consumer to borrow in order to purchase and consume goods. At the end of Q1 2022, the U.S. Trade deficit expanded to record levels of $109.8 Billion, as a broad-based rise in prices, especially for energy lifted imports by 10.3% to a new record high of $351.5 billion. Oil import prices jumped to $87.2 billion a barrel in March compared to $76.37 in the previous month. Also, sharp increases were seen in purchases of finished metal shapes, crude oil, cotton apparel and household goods, footwear, furniture, computers, passenger cars, transport and travel. Exports also reached a new record of $241.7 billion but increased 5.6%, much less than imports. Shipments rose mainly for crude oil, fuel oil, natural gas liquids, autos and parts, transport and travel.

Why the Dollar has strengthened, withstanding Fiscal and Trade Deficits

The reason can be researched and factorised on many levels, it could be argued that Net Exporters of goods receive inflows of U.S. Dollars that have not yet been converted into a Country’s National currency, which could be the Euro, The Yen, the Yuan Renminbi. What we have seen so far has been a strengthening of the U.S. Dollar, withstanding also net outflows from U.S. Equities and Financial products at large, in a complete risk-off environment determined by considerable Inflationary pressures on input costs and retail consumer prices, commodities shortages and considerable supply-chain disruptions. In this environment, the money market interest rate differential has skewed the U.S. Dollar trade as a defensive hedge with Asset Managers clearly withdrawing liquidity from Stocks and other ETFs products, while the Deflating of the Stock Market assets bubble develops; to which a money market interest rate hiking cycle to combat Inflation and a gradual reduction in the Federal Reserve Balance sheet, will require Financial Institutions to have sufficient liquidity out of risk assets in order to absorb the QT flows in credit and money markets of Treasuries and Mortgage-Backed Securities.

What does imply the Trade Deficit for the U.S. Economy?

Trade deficits reflect the savings/investment shortfall, which means the United States is borrowing from abroad. One major concern is the debt accumulation from sustained trade deficits. Ultimately, whether borrowing to finance imports is worthwhile depends on whether those funds are used for greater investments in productive capital with high returns that raise future standards of living, or whether they are used for current consumption. If U.S. consumers, businesses, and the government are borrowing to finance new technology, equipment, or other productivity-enhancing products, borrowing results in a deficit and can be paid off because such investments are expected to result in higher economic growth. However, borrowing to finance consumer purchases (e.g., clothes, household electronics) pushes repayment to future generations, without investments to raise the ability to finance those repayments. Some economists also warn that under certain circumstances, a rising U.S. trade deficit could spark a large and sudden fall in the value of the dollar, risking financial turmoil in the United States and abroad.

How Incomes and the rate of savings variables could be factorised in the U.S. Dollar

The average United States rate of savings has been retracing to the longer-term average from the 2020 unusual peak, in fact, the Saving Rate in the United States was 6.2% at the end of Q1 2022, which could hint at a U.S. consumer balance sheet converging to the historical average. In terms of U.S. Dollar exchange rate levels diminishing savings could in a sense determine weaker U.S. Dollar dynamics.

United States Personal Savings Rate

Average American Income increases would not compensate for the high Inflation of 8.3% CPI

income increased by $107.2 billion (0.5%) in March, according to estimates released today by the Bureau of Economic Analysis. Disposable personal income (DPI) increased $89.7 billion (0.5%) and personal consumption expenditures (PCE) increased $185.0 billion (1.1%).

Real DPI decreased 0.4% in March and Real PCE increased 0.2%; goods decreased 0.5% and services increased 0.6%. The PCE price index increased 0.9%.

United States Personal Income

The USDollar strength derived also by the U.S. Treasury turning a net seller of Foreign Exchange Reserves

The macro-economic data of a combined Fiscal and Balance of Trade Deficit, also defined as primary and secondary account deficits, would in any scenario describe a weak currency exchange rate. However, other factors can get into the U.S. Dollar exchange rate equation, that can be as effective as turning a Net Seller of Foreign Exchange Reserves. In this case, setting apart the constantly blamed Federal Reserve; instead, foreign fiat money reserves are dealt with, by the U.S. Treasury Department. That’s how only by the end of Q1 2022, the United States Foreign Exchange Reserve has decreased by $1.0 Billion. $40.4 Billion decreased to $39.2 Billion dollars.

United States Foreign Exchange Reserves

The U.S. Treasury Department can dump another $19 Billion dollars in Foreign Exchange Reserve

Foreign Exchange Reserve could decrease to levels near or similar to the year 2000, while the stock market goes through a very large correction in order to Deflate the stock market assets bubble and Inflationary pressures in the economy. Thereby, the U.S. Treasury Department can eventually utilize about $19 billion in Foreign Exchange Reserve in order to defend the U.S. Dollar, withstanding very large primary and secondary account deficits.

United States Foreign Exchange Reserves

The Dollar Index can pull back by -1.75% in the near term

The Dollar Index chart on a weekly time scale still defines a clear uptrend slope, although the overshoot outside a consolidated 7-years trading range has been sold off quite effectively, where a Bearish Engulfing Marubuzo clearly gives a hint of a -1.6%<-1.75% decline to DXY 101 for a price/volume trendline gap, that would then get into play the Ichimoku Tenkan line support and a wider resistance DXY range 99<101, that could then become support. However, there can be a possibility of the Dollar Index adjusting toward the middle of the range that would provide a DXY 96<97 support level.