Saturday , 13 August 2022

Why Does the USD Typically Decline At the End Of the Year?

The seasonal trends of the U.S. dollar are probably important for you as an investor in stocks or bonds so let’s take a look at the seasonal pattern of the U.S. Dollar Index and find out why it typically decline at the end of the year.

This post by Lorimer Wilson, Managing Editor of munKNEE.com, is an edited ([ ]) and abridged (…) excerpt from an article by Dimitri Speck, for the sake of clarity and brevity to provide you with a fast and easy read. Please note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

The US Dollar Index is an index that represents the value of the USD, in the form of a basket containing six currencies (Source: Wikipedia):

  1. EUR (euro): 57.6% weighting
  2. JPY (Japanese yen): 13.6% weighting
  3. GBP (British pound sterling): 11.9% weighting
  4. CAD (Canadian dollar): 9.1% weighting
  5. SEK (Swedish crown): 4.2% weighting
  6. CHF (Swiss franc): 3.6% weighting

The U.S. Dollar Index (DXY) directly shows the trend in the external value of the USD, rising when the USD appreciates, and conversely declining when the USD weakens so it is well suited for seasonal analysis of the USD.

The bar chart below shows you the return of DXY for the past 50 years for the period between December 1 and January 1 of the following year. In red you can see the years in which there were losses, in blue those in which there were gains. Most of the time, it went down sharply.

Return in percent of the US Dollar Index between December 1 and January 1, for every year since 1971

As you can see, most of the bars point downwards. In 34 of the 50 cases, the USD fell until the end of the year. Noticeably, this has also been the case for the past four years. On average, a decline of just under 1% was moderate, as is usual for currency markets.

…The seasonal chart below shows the typical pattern of the USD in the course of a calendar year… It has been calculated as the average of the returns generated over the past 50 years. The horizontal axis shows the time of the year, the vertical axis the level of the seasonal index. Thus one can discern the USD’s seasonal pattern in the course of a calendar year at a glance.

As can be seen, there is a seasonal decline in the USD Index as the end of the year approaches.  It loses ground particularly quickly in the second half of December. Thereafter, it typically appreciates again in January (turning point highlighted in the chart).

Return in percent of the US Dollar Index between December 1 and January 1, for every year since 1971

If you look at the chart closely, you can see that the trend reversal occurs right at the turn of the year…[and it is] driven by U.S. tax legislation. Many U.S.-based companies save on their tax liabilities by reporting small amounts of cash at the balance sheet date at the end of the year…[by shifting] money to the accounts of overseas subsidiaries and the resultant additional demand for foreign currencies affects the exchange rate. This is why the USD typically declines at the end of the year and, after the turn of the year, the tide immediately turns. Companies transfer sizeable amounts back to the U.S….

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