The U.S. dollar strengthened after a weak start to the year, with the dollar index climbing as high as 90.74 on Friday. The strengthening seems almost counterintuitive. It comes the day after President-elect Joe Biden outlined his $1.9 trillion stimulus plan. More stimulus should be bad for the dollar because it increases the nation’s debt.
Fed Talks Tapering
Indeed, the dollar index started the year out at around 89.20 in the first trading week. Treasury yields have begun to recover, which is providing support to the greenback. Investors expect inflation to pick up due to the large amounts of stimulus expected from the Democrat-led government.
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The forex space is focused on the comeback in the dollar over the last two weeks. The greenback pulled back slightly on Thursday when Federal Reserve Chairman Jerome Powell said it wasn't time yet to talk about tapering. Longer-term Treasuries also sold off after his speech, with the 10-year yield rising 4.1 basis points, while the 30-year yield climbed 5.2 basis points.
The dollar has also benefited from ongoing expectations of an economic recovery in the U.S. Meanwhile, European countries are locking down again to battle the next COVID-19 wave.
Dollar Index Versus Bitcoin
Meanwhile, the dollar index also provides clues about what to expect in cryptocurrency prices. Due to its emerging status as a safe haven, bitcoin has begun to trade at an inverse correlation to the dollar. Newsbtc argues that some bitcoin traders took profits and reallocated some of their profits into the cash and bond markets.
In its recent meeting minutes, the Fed hinted at reducing the size of its bond-buying program by January 2022. Then bitcoin approached its record high above $41,000 days later, setting the stage for some healthy profit-taking.
The Fed won't start to taper until the economy recovers to satisfactory levels. Powell said he they want to allow inflation to run above 2%. He also said the Fed would keep buying bonds at the same rate until the labor market recovers. Any recovery that arrives will come after lawmakers roll out even more stimulus, which Biden is already planning before he even takes office.
Soaring federal debt will weigh on the dollar for now, which could mean good things for bitcoin again. The cryptocurrency has been battling with gold for dominance as a safe-haven currency. The recent correction in the bitcoin price coincided with the dollar's recovery. The dollar index is now breaking out of its falling channel and lifting back up, which could weigh on bitcoin in the meantime.
What's Next For The Dollar?
FX Street reports that a break above 90.92 for the dollar index opens the door to 91.01, which was the weekly high around Dec. 21. Since the index has already broken above that level, it does look like there's a chance for it to recover even further. However, the setup for the dollar remains fragile with the large amounts of stimulus expected in the coming weeks.
If the dollar index reverses course again and falls as low as 89.20, it could fall even lower to 88.94 or even 88.25.