The US dollar will soon start to slide

The US dollar enjoyed its best quarter since 2018 in the first three months of this year, driven by higher US Treasury bond yields. But the period of dollar strength should ultimately fade away.

Don’t bet against Uncle Sam. Market analysts were sure of one thing at the start of 2021: the dollar was due a fall. A strong global recovery, combined with fears of government overspending in Washington, meant investors were expected to swap their greenbacks for a more colourful collection of international currencies. Instead, the US dollar index, which measures the currency’s value against a basket of six major trading partners’ currencies, has gained 2.3% so far this year. 

The greenback enjoyed its best quarter since 2018 in the first three months of this year, says Eva Szalay in the Financial Times. It gained an impressive 7.2% against the Japanese yen. The dollar’s strength has been driven by higher US Treasury bond yields. The US ten-year yield has risen from 0.9% at the start of the year to 1.65% today. That has made it more attractive relative to bonds in other currencies.

If anything, the real question is why the dollar isn’t even stronger, says Aaron Back in The Wall Street Journal. While the dollar index has gained in 2021, it has actually fallen by 7% over the last 12 months. It seems that investors fear an inflationary sting in the tail. The US Federal Reserve has made clear that it is much more relaxed about inflation than it used to be. Higher inflation means lower purchasing power per unit of currency, so the prospect of a US inflationary surge would be bad for the dollar. 

An incipient US boom means the greenback may stay strong in the short-term, say Will Denyer and Tan Kai Xian for Gavekal Research. But while the Biden White House has so far focused on splashing the cash, tax hikes and more regulation are also on the agenda. As the rest of the world catches up with the US recovery, this period of dollar strength should ultimately fade away.

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