What’s unsettling the US dollar?

As the US dollar weakens, it pays to understand why it was so strong in the first place – and what’s changed, says Sean Corrigan of Cantillon Consulting.

The dollar has had the worst year since 1985, the headlines have screamed for this past week or so. There is no doubt that the US currency has been struggling (the precise truth of the statement rather depends on the specific dollar index one uses). Yet it comes after five and a half years of notable strength, during which the dollar rose by around 45%.So rather than look at why the dollar is now falling, it may be more informative to look at why it was strong in the first place and at what has changed.

One significant factor driving the dollar higher has been the global appetite for US corporate debt, of which foreign buyers have bought more than $350bn over the last two and a half years. This has made a meaningful contribution to the whopping $860bn issued by US non-financial corporations over that time, which in turn has been used to fund roughly two-thirds of their $1.3trn-plus of stock buybacks. Although a good part of this overseas demand will have been currency-hedged, not all of it has been, thus helping to push up the dollar alongside the S&P 500 (now at an historically elevated level in relation to its global peers). Much of this appetite for US bonds has arisen from the urgent need to escape central-bank-engineered negative yields at home. For example, as a result of Mario Draghi at the European Central Bank (ECB) continuing to do "whatever it takes" long after the obvious need to do so has passed, the yield differential (or "spread") between US Treasuries and their German counterparts had recently reached its highest level since the fall of the Berlin Wall.

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