Why is the US dollar so strong?

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As anyone who buys or sells abroad knows, the US dollar is at a 20 year maximum against the Euro (basically, since the beginnings of the Euro, when many doubted that it would survive)

There are many reasons for this situation, but two stand out.

First of all, high inflation is forcing central banks to raise interest rates. The US is always faster to react (more about this later), right now rates are 1.25% in Europe and 3.25% in the US. This means that a lot of the big guys have sold their EUR to buy USD, because they get a higher interest for their money, so the EUR goes down and the USD goes up.

On the other side, the strenght of a currency reflects the strenght of the economy of the area related to it. US economy expectations are not that good, with a covert civil war and a recession looming because of high inflation. But Europe economy expectations are much worse. On top of high inflation, a lot of analysts have been hammering us about how terrible the next winter in Europe will be, how the energy prices will skyrocket and how we will all freeze to death. So investors are scared, and flee Europe to invest in less apocalyptic places.

Both these points pull the USD up and the EUR down, and the current exchange rate reflects this situation.

So what’s next? Facts move markets and investors, but expectations move them even more. And both expectations will change.

Winter in Europe will come and go, situation will be terrible or it will not. We will probably survive the winter, and expectations about the future of Europe will improve. Basically because after winter, spring and summer come, and energy usage goes down sharply. Furthermore, all the measures that Europe is taking to cut its dependence on Russia (ahem, Germany) will begin to kick in. So expectations will improve and some investors will come back

An regarding interest rates… well, there is a limit, you can not raise them forever. Let’s take a look at history:

interest rates usd vs eurAs we can see that the Fed is always the first mover: it raises or lowers interest rates sooner and harder than the ECB. So for a moment, there is a strong incentive to buy USD. But when we reach the plateau, the equation gets back to normal.

We are clearly in a situation that is not normal:

 

So as winter arrives, we should get back to the averange prices. But Putin still has a lot to say, and he can not back off now, so things might get worse before they get better. And if he presses the button, then we will die by thermonuclear cooking, instead of frozen. Tough choice.

Marc Torras