A Favorable Dollar Outlook
November 18, 2019
The dollar has performed well for nearly two years now, advancing by around 9.5% compared to its January 2018 low on a trade-weighted basis against other major traded currencies. Relative to specific currencies in that span, the greenback has appreciated 12.0% against the euro, 11% versus the Chinese yuan, 9.2% vis-a-vis sterling, and 5.1% against the Swiss franc, while losing just 0.6% versus the yen. Most of the gains were accrued in 2018. but 2019 has not seen any appreciable reversals.
Several of the main factors supporting this bull run remain. For one thing, short- and long-term interest rate differentials continue to favor U.S. assets by a big margin in spite of three cuts of the federal funds target since midyear. The target ceiling lies 225 basis points above the ECB deposit rate and 185 basis points above the Bank of Japan’s policy rate, and U.S. ten-year Treasury yields surpass their German and Japanese counterparts by 194 bps and 185 bps. Fed officials are neither anxious to augment recent easing nor to reverse the trio of cuts.
U.S. macroeconomic fundamentals also stack up well against other economies. On-year growth in GDP last quarter was almost twice as great in the United States as in the euro area, U.K. or Japan. Growth has fallen quite short of President Trump’s goals, but weakness doesn’t seem to have intensified unduly. CPI inflation of 1.8% in the United States remains somewhat lower than desired by not nearly as much so as the cases of Euroland or Japan where such is 0.7% and 0.2%. There is a contrast between America’s current account deficit and surpluses in Japan and Euroland, but the relative size of the U.S. deficit of roughly 2.5% of GDP is quite manageable based on dollar history. Past cumulative downswings in the dollar tended to be associated with current account deficits of a considerably larger relative size.
The United States continues to attract foreign capital for a variety of reasons beyond the relatively appealing interest yields. U.S. nonfarm labor productivity rose 1.3% in both 2017 and 2018 and 1.6% on year over the first three quarters of 2019 including 1.4% in the third quarter. The dollar’s hegemony in reserve currency portfolios is still heavily dominant. The global landscape offers plenty of uncertainties that favor hot-money inflows to the United States, which retains a safe-haven aura in spite of the Trump Administration’s abandonment of traditional U.S. foreign policies.
At quick glance, the possible impeachment of President Trump,uncertain outcome the U.S.-Sino trade relations, and 2020 U.S. election represent potential dollar pitfalls. Whether the House of Representatives impeaches is less important, less predictable, and less meaningful than the almost certain outcome of acquittal should there be a senate trial. In 1974, when Nixon resigned to avoid certain conviction by the senate, the dollar sold off in the last third of the year and early the following year, but in 1999, after Clinton was exonerated, the dollar performed well. In a year when trade relations with China were often very tense, the dollar held its own. It seems likely that Trump will make sure that a deal is reached and will trumpet the result as a huge victory for America even if it in fact lacks much substance. Like impeachment, trade talks on closer examination do not seem so threatening to the dollar.
Regarding the 2020 election, its interesting to note how little the dollar has moved on net against the euro in past U.S. presidential election years. In those seven instances, the dollar on a yearend to yearend basis rose five times (7.2% in 1996, 7.1% in 2000, 6.2% in 1992, 4.5% in 2008 and 3.2% in 2016) and fell just twice (4.5% in 2008 and 3.2% in 2016). In none of the years was the net dollar change as much as 7.5%. The same cannot be said about the dollar/yen relationship. Although the dollar fell more times than not (18.7% in 2008, 4.6% in 2004, 2.7% in 2016 and 0.1% in 1992), each of the three election years in which the dollar rose against Japan’s currency, the size of the net advance surpassed 12.0%: 12.8% in 2012, 12.3% in 1996, and 12.1% in 2000. The fact that 2020 is a U.S. election year may herald a big swing in the yen, but past experience doesn’t say much about the likely direction of the move.
Copyright 2019, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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