Multi-Asset Insights: Where next for the US dollar?
Over the past 15 years, the global economy has had a tailwind from US dollar weakness, the recycling of petro dollars and trade surplus reserves, and considerable US dollar borrowing.
However, the sharp appreciation in the US dollar over the past two years has placed considerable stress upon the global economy.
Impact on China
The most direct and meaningful impact of a stronger US dollar has been on China, with the nation’s pegged exchange rate importing US monetary conditions into the nation. Growth in China has slowed as export growth has diminished due to a loss of competitiveness (Figure 1).
Downward pressure on growth has led to domestic easing in an attempt to counter this, with the combination of reduced investment opportunities and lower interest rates leading to capital outflows (Figure 2) – placing downward pressure on the Chinese yuan (CNY) peg and exporting deflationary pressure on the global economy.
Impact on the US
A strengthening US dollar has contributed to tighter US monetary conditions. US dollar strength has diminished the competitiveness of the US economy and weighed on what were previously bright spots: the manufacturing and industrial sectors.
This is a result of a decline in the demand for US exports as the exchange rate has appreciated, but also due to the import substitution effect.
This has caused the US trade deficit, ex-energy products, to return to levels reached in the mid 2000s – the height of the US-China circular trade relationship.
Potential for USD to weaken
A weaker US dollar would provide relief to the various pressures weighing on the global economy, such as Chinese capital flows, the CNY, commodities, emerging markets and the US economy.
A weaker US dollar, however, requires an appreciation in other major currencies. We see little ability or willingness for this to take place.
We believe appreciation in either the yen or the euro would slow these economies quickly, while both the Bank of Japan and European Central Bank appear unwilling to allow meaningful strength in their currencies because of this.
We believe we have reached the point where policy divergence has become destructive, with any further sharp appreciation in the dollar coming from a rebound in US growth in turn putting pressure on global growth.
We also see limited ability for the dollar to weaken against major crosses given the lack of ability or willingness for these economies to accept stronger exchange rates.
Our expectation is therefore that major currencies will likely remain range-bound until there is greater evidence that economies have been able to adjust and withstand the pressures being placed upon them by a stronger US.
If the US economy slows and the Fed becomes increasingly dovish, this is supportive of assets like gold, given a lack of ability or willingness for the dollar to weaken against other major currencies.
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