The US dollar is ripe for sharp depreciation

The US dollar – usually considered a traditional “safe haven” refuge – suffered its worst monthly performance in nearly a decade last month as risk-averse investors shunned it. 

Has the greenback reached a turning point? The US dollar index gained more than 10% between March 2018 and April 2020. The index measures the greenback’s value against a basket of six major trading partners’ currencies. Yet that trend has now gone into reverse, with the dollar falling by 4.4% in July, its worst monthly performance in nearly a decade. It is down by 9% from a mid-March high and has reached a two-year low. 

Debasement, debt and dodgy institutions

The dollar’s reversal will have broad implications, says Amrith Ramkumar in The Wall Street Journal. The strong dollar was driven by US interest rates, which were higher than those on offer in Europe or Japan. That encouraged yield-hungry investors to park cash in dollar assets. Yet the US Federal Reserve has now slashed rates to near-zero and quantitative easing has expanded its balance sheet by almost $3trn in five months.

The dollar is still not particularly weak on a historical basis, notes Neil Shearing of Capital Economics, remaining above its ten-year average valuation in trade-weighted terms. Yet something mysterious is afoot. Risk-averse investors have been crowding into safe havens such as bonds and gold, but the dollar, another traditional refuge, has been shunned. 

What’s more, US inflation expectations have risen recently even as stocks remain stuck. The explanation may be that markets are positioning for a “regime shift” in US monetary policy, with a Federal Reserve that “tolerates – or indeed targets – higher inflation”. That makes the greenback a less attractive asset than it once was.

The dollar’s turnaround raises questions that “go to the heart of the global financial system”, say Colby Smith, Eva Szalay and Katie Martin in the Financial Times. Some 88% of deals in the $6.6trn foreign exchange market involve the greenback. Investors are now questioning whether US institutions can withstand a period of intense political polarisation. Donald Trump’s recent suggestion that the election should be delayed has hardly allayed fears of civil strife.

A boon for stocks

American political dysfunction compares unfavourably with Europe, which is taking unprecedented steps towards fiscal union, says Stephen Roach in Project Syndicate. A rising euro has been a significant factor driving the dollar’s recent fall. The macroeconomic picture is also unfavourable for the greenback, with the US running a current account deficit while the eurozone runs a surplus. All this suggests that an “overvalued US dollar is ripe for a sharp devaluation”. 

Many will cheer a weaker dollar, says Reshma Kapadia in Barron’s. It could spark a boom in emerging markets by providing cheaper financing costs for local businesses. A falling currency also bodes very well for American stocks because a weaker currency flatters the overseas earnings of US companies when translated into dollar terms. David Kostin of Goldman Sachs notes that a 10% fall in the trade-weighted index boosts S&P 500 earnings per share by 3%. 

Recommended

What is Rihanna's net worth?
Entrepreneurs

What is Rihanna's net worth?

Rihanna became the youngest self-made billionaire in 2022. Here’s how she made her money.
2 Jun 2023
Best savings accounts – June 2023
Savings

Best savings accounts – June 2023

Interest rates have been creeping up - we look at the best savings accounts on the market right now.
2 Jun 2023
Share tips of the week – 2 June
Investments

Share tips of the week – 2 June

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
2 Jun 2023
The best one-year fixed savings accounts - June 2023
Savings

The best one-year fixed savings accounts - June 2023

You can now earn 5% on 1 year fixed savings accounts - the best rate seen in 14 years. We have all the latest rates available now.
2 Jun 2023

Most Popular

June’s NS&I Premium Bond prize draw - are you this month’s millionaire?
Savings

June’s NS&I Premium Bond prize draw - are you this month’s millionaire?

Two fortunate NS&I Premium Bond winners are now millionaires. Find out here if you’re one of them.
1 Jun 2023
3 renewable energy stocks to buy
Investments

3 renewable energy stocks to buy

These stocks look poised to benefit as the world transitions to a net zero economy.
31 May 2023
Housing slowdown ‘deeper than anticipated’ as property sales slump
House prices

Housing slowdown ‘deeper than anticipated’ as property sales slump

New data from HMRC shows a fall in property sales - now experts predict a delay to the housing recovery
1 Jun 2023