Dollar’s Enjoyed a Stellar First Half Without Typical Currency-Supportive Fundamentals

July 20, 2022

Since the end of 2021, the dollar has appreciated 11.7% against the euro and 20.2% against the yen. Those advances compare highly favorably with the dollar’s January 1 through June 30 movements in the years since the euro was launched in 1999. First-half changes against the euro in the previous six years included declines of 7.8% in 2017, 2.1% in 2016, and 0.2% in 2020 and modest appreciations of 3.0% in 2021, 2.8% in 2018, and 0.6% in 2019. The only years with comparable first-half performances against the euro were 2010 (17.1%), 1999 (+13.2%), 2005 (12.3%) and 2001 (10.9%). In two of those years, the dollar settled back significantly in July and posted year-to-July 20th advances of 6.8% in 2001 and 5.1% in 2010. the euro’s first year, 1999, was a special case because investors were worried that the merged currency might only survive a couple of months.

The dollar’s advances since the end of 2021 against the yen of 18.0% through midyear and 20.2% as of now are even more impressive than the U.S. currency’s recent performance against the euro. Going back to 1999, the next largest first-half gain against Japan’s currency was one of 14.4% in 2013 and behind that ones of 8.9% in 2001 and 8.0% in 2005. In fourth place was a 7.6% rise in the first half of 2021. Drilling back all the way to 1981, only a 16.8% advance in the first half of 1982 was really comparable to this year.

Periods of significant dollar strength in the past have been associated with certain economic fundamentals that one doesn’t really find in 2022. One golden age of the dollar, the first half of the 1980s, saw inflation decelerate very sharply amid a mix of loose fiscal policy and a very tight monetary tourniquet. U.S. CPI inflation nearly doubled from 5.4% in mid-2021 to 9.1% last month. The Federal Reserve didn’t begin raising its interest rate until this past March and the 1.75% federal funds rate remains well below a neutral stance when  a restrictive policy is what’s truly needed. From all the conservative complaints about deficit spending, one wouldn’t realize that fiscal policy has actually been a source of considerable drag during the past year. Government spending at an annualized rate fell 2.9% last quarter and 2.6% in 1Q, and such previously had dropped 2.0% in 3Q 2021 followed by a mere 0.9% uptick in the final quarter of last year. The drop in public expenditures last quarter exerted a negative 0.5 percentage point effect on the quarter’s GDP growth rate.

All of which brings one to the slow pace of GDP expansion during the first half of 2022. The first quarter saw GDP contract at a 1.6% annualized rate, and first-half GDP growth doesn’t appear likely to be more than marginally above zero percent on average. Looking ahead, officials at the Bank of Canada are assuming more economic growth in Japan for combined 2023-24 than in the United States, and they expect Euroland to expand faster in 2024 than the United States.

Periods of dollar weakness historically have typically been associated with spikes in the relative size of the U.S. current account deficit. The deficit was a big investor concern that kept recurring in the second half of the 1970s. In 2006 when the dollar dropped 7.6% versus the euro and 2.9% against the yen during the first half of the year, the current account gap swell to 6.0% of GDP, breaking thresholds experienced in earlier eras of dollar turmoil. The first quarter of 2022 saw the deficit jump to 4.8% of GDP from an average 3.6% of GDP last year and 2.2% in the last pre-pandemic year of 2019.

As the lynchpin of the international monetary system, the dollar enjoys huge intrinsic advantages. The dollar inherited that role after World War II because America offered attractive intangibles to investors, like the rule of law, political stability, boundless natural resources, military strength, and a well-educated and skilled workforce. The contrast of that image is stark when set against present circumstances in which one political party no longer promotes democracy, Congress is tied up in knots, the Supreme Court has lost immense credibility, the president’s voter support has plummeted, and a cohesive sense of a common national identity has unraveled. It will be a miracle with inflation soaring and a constitution that doesn’t work for the 21st century if the country gets through the November election without lurching more deeply into authoritarianism. Coup attempts after then will be much more likely to succeed than the January 6th insurrection was.

Looking at currency market behavior, one is tempted to assume that the political backdrop simply has little influence over the dollar. But an examination of currency performances in other countries, past and present, suggests that one shouldn’t be so complacent. Look at the values of the German and Japanese monies coming out of the Second World War. The same can be said more recently about the Argentine peso, Turkish lira, Russian ruble, Sri Lankan rupee or Hungary’s forint.

What the dollar has going for it has been favorable interest rate premiums. While the U.S. currency entered the second half of 2022 with plenty of momentum and the prospect of even more attractive yields, a fuller picture of all fundamentals upon which the dollar’s fate may likely hinge suggests that yields might not be enough to keep the rally going through the balance of this year and into 2023.

Copyright 2022, Larry Greenberg. All rights reserved. No secondary distribution without express permission.





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