For Better or Worse: USDX linked to Fed Action

It was a pretty topsy-turvy ride for the Greenback in 2012. From central bank action, to risk sentiment, to presidential elections, there were many catalysts for strong moves on the USDX.

USDX

Risk Sentiment Drives the Dollar

Was it really less than a year ago that I really posted an article that hinted at the possibility that EUR/USD could hit parity?

Well, I was wrong, but how could you blame me?! With concerns about Greece and Spain weighing heavily on the markets, there was a legitimate argument that the dollar could benefit from some risk aversion.

To some extent, this was true, as the dollar was relatively stronger during the first half of the year.

Slowly though, we started seeing the comdolls be more and more resilient. Later on, the European currencies gained steam and trampled all over the Greenback as European leaders systematically tackled debt concerns. Once Mario Draghi promised to do everything possible to preserve the euro, traders started buying up risky assets like there was no tomorrow!

This didn’t bode well for the scrilla, which took a major hit during the third quarter. After peaking around 84.50 in mid-July, the USD hit a stretch where it closed lower 8 out of the following 10 weeks!

Fed Flip-Flops on QE3; Finally Gives In

Early in March, it looked like the Fed wasn’t quite ready to pull the QE3 trigger, as Fed head honcho Ben Bernanke said that it wasn’t the time for it.

However, a couple of weeks later, Bernanke did a complete 180 degree turn by saying that economic conditions may warrant additional easing measures! A few weeks after that though, the Fed barely mentioned more asset purchases in another statement! Talk about keeping traders on the edge of their seats!

The tug-of-war on whether the central bank would step up its bond-buying ways continued throughout the year, until the Fed finally laid the smackdown on Uncle Sam and announced that it would be increasing its monthly asset purchases by another 40 billion USD in September!

One of the bigger surprises though, was that Bernanke didn’t put a limit to the amount of purchases the central bank could purchase. Of course, only a few months later, Bernanke made use of this leeway to add an additional 45 billion USD worth of bonds purchases this past December. In an even bigger surprise, he said that future liquidity measures would be linked to both employment and inflation!

This announcement was unprecedented, as it is normally part of every central bank’s mandate to promote price stability. That said, they normally just keep an eye on inflation. It seems as if the Fed really wants to get the labor market back on its feet ASAP!

Obama Stays in the Oval Office

Thanks to a late surge in votes, Obama won his reelection bid, taking home 303 votes in the Electoral College. He also won the popular vote 50% to 48%.

The initial reaction by the markets was to buy up higher-yielding currencies, as they figured that more Obama-time meant another four years of looser monetary policy. After all, incumbent Fed President Ben Bernanke is Obama’s homeboy, and Obama wasn’t gonna kick him out to the curb like his rival, Mitt Romney, would have.

Interestingly though, once all the smoke cleared, we saw that higher-yielding currencies lost their footing and gave back all their winnings.

Apparently, the markets realized that Obama’s policies could actually be a major obstacle for growth. Keep in mind that Obama is proposing higher corporate, capital gain, and dividend tax rates. These could all put a drag on growth and hurt the U.S. recovery. As a result, traders decided that it was too early to add to their risky positions and decided to just unload later in the day.

Fiscal Cliff Talks Drown the Greenback

Once the Presidential elections were done, the focuses shifted quickly to the U.S. budget and fiscal cliff concerns. After coming up with makeshift deal after makeshift deal, Democrats and Republicans were determined to come up with a deal that would appease both parties.

With the clock entering the 11th hour, Obama and House Speaker John Boehner have continued to wheel and deal, trying to find the right combination of tax increases and spending cuts.

To their credit, after starting miles apart, each side has made concessions to help get the talks rolling. After initially refusing to have any tax increases at any level, Boehner has said that he was open to a tax increase to those earning more than 1,000,000 USD.

On the other side of the table, Obama backed off his demands for tax increases to all households earning more than 250,000 USD, and is now asking for the bracket to be at 400,000 USD instead. Obama also promised spending cuts across various programs that would lead to 1.13 trillion USD worth of savings over the next 10 years.

As of now, no deal has been made, so let’s see how this all pans out. Check back in a week, as I’ll be once again giving my 2013 predictions for the U.S. dollar!

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