Here's a riddle for adults: countries stop using it, analysts predict its decline and regression, but it continues to strengthen. What is it all about? If you answered the U.S. dollar, you are absolutely right.
Despite the expressed plans by BRICS leaders to increase the use of national currencies for trade and investment purposes, the dollar is still gaining dominance.
The latest transaction data compiled by the Swift financial messaging service shows that the dollar's role in international payments has never been more critical. For example, in July, the percentage of transactions involving the dollar reached an all-time high of 46%.
And there are multiple reasons for the U.S. currency's resilience, including the economy's strength and the Federal Reserve's hawkish stance. The lack of certainty on a global scale in geopolitics also plays its part.
Which would you prefer, a Eurozone currency that is one step away from recession or perhaps China that is on the bridge to crisis?
To be fair, there is currently no viable alternative to the US dollar. Although the Chinese currency is slowly integrating into the global monetary flow, its share remains relatively small.
In July, just over 3% of the instructions sent through Swift involved the yuan.
The limited share of the world's second-largest economy's currency can be attributed to its lack of free convertibility.
For those who do not know, there are restrictions on foreign exchange transactions in China, including foreign exchange and foreign currency withdrawals.
In addition, the regulator occasionally intervenes in the foreign exchange market. If the Chinese Communist Party decides to devalue its currency, it can do so. Moreover, in the past, Beijing has periodically resorted to this practice to support its economy.
However, the current situation is quite the opposite.
With the yuan falling against the dollar to its lowest level since 2007 amid China's economic woes, the PBOC will have to sell reserves to strengthen its currency.
Incidentally, this is where the biggest risk to the dollar lies today. If the Chinese regulator starts selling U.S. Treasuries on a large scale, it could cause chaos in the markets.
As the supply of bonds increases, the debt market in the world's largest economy will come under pressure, and this could subsequently spill over into equities, leading to high volatility.
It is, therefore, not surprising that money market fund assets reached a new all-time high. Around $14.37 billion flowed into U.S. money market funds in the week through Aug. 30.
What's in store for the dollar?
The fact that hedge funds are actively reducing short positions on the dollar indicates that it is risky to bet against the US currency. The point is that to combat inflation, there are two options: raise interest rates again, which could lead to bankruptcies and a financial crisis, or cool the economy with a strong dollar.
The problem lies in the unexpected shift among analysts, who have collectively started to predict further strengthening of the US dollar until the end of this year.
As a general rule, it is prudent to exercise caution when there is consensus, which means that if there is a dovish stance next week, the DXY index could fall below the 104 mark.
