A Very Robust Dollar with Continuing Upside Potential

March 23, 2020

The dollar has thrived during the global coronavirus pandemic. In the past two weeks the U.S. currency has advanced between 5% and 10% against the euro, yen, Swiss franc, Canadian dollar, Swedish krona, Turkish lira, Brazilian real, South Korean won and South African rand. It has climbed between 10% and 15% relative to the British pound, New Zealand dollar, and Russian ruble, and by more than 15% relative to the Australian dollar, Mexican peso, and Norwegian krone.

Compared to its 52-week lows, the the dollar has strengthened over 30% versus the Brazilian real, Russian ruble, Norwegian krone and Mexican peso. Advances exceed 20% against Canadian and Australian dollars, South African rand, and Turkish lira. The euro, Swiss franc and Japanese yen, a trio of “hard currencies” that historically have been supported by low inflation and current account surpluses, are now trading near their 52-week lows against the dollar, and sterling came within a half penny of a post-euro era low of $1.1447 earlier today.

The coronavirus crisis has created a supply shortage of dollars both domestically and globally that central banks are attempting to limit. In financial markets, dollars are coveted as a relatively “safe” asset, and in the real economy, both households and companies are motivated to hoard whatever dollars they can.

Economic price theory conceptualizes equilibrium as a single price level that clears the market, matching the quantity supplied of a good or service with the amount that is wanted. So long as the underlying factors that determine the supply and demand functions do not change, the invisible hand of the marketplace should guide the price toward that theoretical equilibrium. When a change occurs in either demand or supply, the equilibrium price moves, and so does the the equilibrium quantity of the good of service.

But in my 4+ decades as a currency market analyst, I’ve often observed equilibrium to manifest not so much as a price point but rather as a price direction. Put differently, currency relationships frequently display an intrinsic tendency to overshoot, drifting off into space until a new meaningful shock is introduced. Small changes in the supply or demand curves do not exceed the threshold needed to stop a directional currency swing. It takes something more dramatic. Such can be a big change in policy like the Fed’s adoption in 1979 of a different operational framework, an unexpected eventful political change like the election of Francois Mitterrand as President of France in 1981, or a technical market trigger like a crossed long-term trendline of currency support or resistance.

The main market mover of the dollar now is the virus pandemic and the considerable uncertainty surrounding its future evolution both from a medical standpoint and the associated impact on the U.S. and other economies around the world. The one constant in all the news chatter is that the virus isn’t going away in days or even a few weeks. A vaccine available to the public as happened with polio in 1955 is probably a year away. So the dollar’s upward momentum is very unlikely to end abruptly by a natural removal of the health menace this month or next.

The dollar isn’t pressing against unchartered territory. The euro got as weak as $0.8228 in October 2000. The yen this century has been as weak as 135.1 per dollar. Sterling would have to fall another dozen U.S. cents to break below its 1985 low of $1.0345.

While an appreciating dollar undermines the objectives of President Trump’s goals on returning the U.S. trade balance to zero, that objective for the foreseeable future is likely to be subordinated to the priority of handling the pandemic and economy in whatever manner gives him the best chance of getting reelected. A focus on trade or debasing the dollar would be a distraction.

In currency forecasting, nothing is 100% guaranteed, and no outcome is impossible to imagine. That said, the odds look favorable that the dollar will continue to be well bid at least over the short term even if interest rates and share prices fall further.

Copyright 2020, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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