Let’s look at the behavior of the DXY, the US dollar index, which tracks the price of the US dollar relative to a basket of six foreign currencies (euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc). The most recent upward trend is nothing new.
Over the DXY’s history, which begins in 1967, we notice two things. First, the US dollar relative to the other developed-market currencies is cyclical, rising and falling over time. This relationship looks very different from the price behavior of capital assets, such as the S&P 500 Index, which tends to increase over time, continually hitting higher lows and higher highs. This difference highlights the push–pull dynamics of currency indices, which represent a trade-off of like things, one currency for another, as opposed to, for example, one currency for shares of a company.
When a nation’s currency trends strongly in one direction (let’s say, a negative direction), the price movement calls attention to structural concerns in that country. The impact can be negative on just that country or on other countries whose currencies strengthen relative to the weakening currency. If the country is a small global trade partner, such as Zimbabwe, a currency collapse, as occurred there from 2007 to 2009, only hurts the local economy. If, however, the currency belongs to a country that is a major player in the global economy, a country with strengthening currency experiences a bidirectional impact (i.e., imports get cheaper, but exports become much more expensive).
The second observation we make is that the price cycles of the DXY tend to last about 8 years. The most recent cycle started around 2010. That makes the current strengthening trend a bit long in the tooth at roughly 12 years. The dollar’s strength may have hit its cyclical peak, and the current pullback is more than temporary.