Oct 17, 2022
VOT Research Desk

Analysis

The DXY Econometric Prognosis

• Using the trade-weighted US dollar index as a proxy, we examine the influence of a number of macro variables on the price of the US dollar.

• The US dollar exhibits greater dependence on the environment of interest rates despite trading off factors that are comparable to those of precious metals.

• Its price was influenced by the money supply, the federal funds rate, and inflation.

Currency performance is typically based on how appealing the assets are in the jurisdiction that the currency represents. The dollar index utilized in this exercise is a weighted average of how much the US dollar has changed in value relative to a basket of other world index currencies. Investors can normally expect to receive a larger return on their investments in a country’s assets when interest rates are higher than they would in a low-rate environment.

As a corollary, capital inflows are encouraged, which causes that currency’s relative value to increase. The most accurate representations of predictor variables may come from interest rates (using the overnight or benchmark rate) and/or a country’s current account, which is calculated as exports less exports plus any other sources of foreign net income.

Another determinant is the amount of money in circulation; if nothing else changes, prices should go down when more money is printed or enters the market. The amount of money in circulation and inflation are strongly related. Theoretically, the rate of inflation and the rate of money supply increase ought to be equal at equilibrium, however this is not always the case (take Japan, for example, where there is a huge printing program but little inflation). Therefore, including both is advantageous for the model.

The federal deficit may also have an impact because it sheds light on a country’s economic performance. A budget deficit is also strongly related to the current account since it equals the trade deficit plus savings minus private investment. In other words, the budget deficit and trade deficit are equal if private investment and savings are equal.

Real GDP growth is already included in the dataset, however it shouldn’t be statistically significant, making it basically useless to run. Genuine GDP and the cost of the dollar should be positively correlated because of the US, and they are (+0.19), but a strong or helpless currency shouldn’t be a key indicator of monetary improvement. An economy does not always benefit when a currency appreciates. A country that places a greater emphasis on its customers would certainly benefit from a stronger currency because it would boost local consumers’ spending power.

A stronger currency would likely have a net negative effect on an economy that relies more on exports because it would raise the price of its goods to partners in foreign trade, making them less appealing. A stronger currency should generally encourage growth given that the United States is a net importer rather than an exporter. In addition, rather than the other way around, the currency rate would be more of a predictor variable for GDP.

To be regressed on the dollar index, these major independent variables were collected:

• Personal consumption expenditures price index (PCEPI) inflation in the United States.

• The actual rate for federal funds.

• The ratio of the US current account to GDP.

• The surplus/deficit of the US federal government in relation to GDP.

• The supply of US M2 money.

However, statistical significance is also given to the federal deficit.

Higher interest rates proved to be beneficial for the dollar by having an effect on the demand side of the market. Both a more favorable fiscal budget scenario (higher surplus or lower deficit) and a more positive current account scenario (capital inflows plus a healthier overall financial position) were bullish for the dollar because they indicate capital inflows in the case of the former and capital inflows plus a healthier overall financial position in the case of the latter. Due to their effects on the supply side, higher inflation and an increase in the money supply were both negative.

If everything else stays the same, a one percent change in the rate of inflation has a bigger influence on the value of the dollar than a one percent change in the federal funds rate. A 1% change in the current account is less significant than a 1% change in the federal deficit as a percentage of GDP.

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