The Dollar

The protracted weakness in the US dollar since markets settled down from President Trump’s surprise election win has been one of the biggest macro stories of 2017. And the consensus is there is yet more downside in store for the greenback.

The protracted weakness in the US dollar since markets settled down from President Trump’s surprise election win has been one of the biggest macro stories of 2017. And the consensus is there is yet more downside in store for the greenback.

After climbing sharply in 2014, as the US took its foot off the pedal of the quantitative easing program, the dollar remained at elevated levels until the start of 2017. At this point the the DXY – which is the index of the dollar against a basket of major currencies – registered a 14 year high with financial markets basking in the afterglow of euphoria from Trump’s victory.

Election promises of waves of infrastructure spending and tax cuts helped the dollar soar higher, as the outlook turned to reflation and growth. But as one legislative failure followed another, investors began to realize that the higher growth – and with that higher interest rates, would not be such a straightforward matter.

What we’ve seen since the start of 2017 is a 11% decline in the DXY and there’s never been a time when the dollar has dropped so much without entering a bear market. But it’s not just a story about the US. The biggest component of the DXY index (approximately 60%), is the euro. And with growth resurgent at the core of the European Union, particularly Germany, the outlook for relative interest rate differentials and growth has seen Europe outperform the US with more investors moving into EU assets.

One of the key planks of the strong dollar thesis that had previously dominated market attention has been the outsized level of dollar denominated debt owed by nations around the world (this has now passed $10 trillion). The relative cheapness of borrowing in dollars over the last few years has seen sovereigns load up on US dollar debt, particularly emerging markets and countries in Europe and Japan. This debt hasn’t gone away and the theme that there aren’t enough dollars to go around will likely return to the fore, particularly if US interest rates rise.

For now, consensus is firmly in the camp of a weaker dollar and stronger euro. Interestingly, in  his Real Vision interview, renowned trader Alex Gurevich of HonTe Investments made the case that if you think the dollar is going to be weaker going forward then the better trade is in the bond market.

The flip side of the weaker dollar is the benefit to US companies that can increase exports and compete better overseas without taking a hit to corporate profits. We’ve already seen some of that spillover into gains in the equity market. Traditionally a weaker dollar tends to support the commodities market and that’s also global growth positive. Furthermore, under normal circumstances, the absence of a strong dollar is beneficial to emerging market economies in terms of growth. But with the kind of market activity that has been seen recent years, perhaps history is not the best guide to future outcomes.