The dollar is signaling a global recovery, but paradoxically, it is sending very mixed signals about the outlook for the world’s largest economy, the United States itself.
Global markets are shifting to a “risk-oriented” environment as vaccinations for the new pneumonia crown increase and the world begins to contain the outbreak. Historically, this environment has weakened the dollar as capital flows to riskier, higher return environments and U.S. equities.
Since topping out last March, the dollar has lost about 13% of its value against the euro, and the dollar has fallen as much as 27% against the Australian dollar. Some data show that the short position of the Australian dollar against the dollar reached the highest level in nearly a decade.
Earlier this month, the downward trajectory of the dollar exchange rate was halted as the possibility of a new $1.9 trillion crown pneumonia bailout package by U.S. President Joe Biden increased, but then resumed its downward trend due to weaker-than-expected economic data.
Data show that the dollar’s share of foreign exchange reserves is at its lowest level in 25 years. The eurozone’s historic decision to issue collective bonds last year is another potential indication of a shock to the dollar’s strong position.
With this in mind, Stephen Roach, a Yale economist and noted big dollar short, predicts another sharp depreciation of the dollar.
The dollar’s weakness, however, seems to contradict the spike in U.S. bond yields as the U.S. economy recovers faster than expected.
It is important to know that with the upward movement of U.S. bond yields, a large amount of capital should have entered the U.S. bond market and provided support to the dollar.
In response to this contradictory phenomenon, some analysts have pointed out the crux of it.
The U.S. debt surge and budget, trade double deficit, so that Biden’s stimulus package into a double-edged sword. If the stimulus bill comes out successfully to greatly increase the supply of dollars, the supply will completely exceed the potential demand.
Indeed, the 10-year U.S. bond yield has risen nearly 20 basis points since the beginning of the year, and the yield on the 30-year U.S. bond has risen by as much as 32 basis points, but with the economic outlook and the subsequent impact of the stimulus bill uncertain, the rise in yields has not been enough to attract significant foreign capital inflows. Therefore, the most attractive market for international capital in the U.S. at the moment is still the stock market.
It is well known that there is a negative correlation between the U.S. dollar and stock markets as well as commodity prices, as a weaker dollar makes the vast majority of U.S. dollar-denominated stocks and commodities cheaper.
Since emerging economies also carry large dollar-denominated debt, a weaker dollar not only lowers their economic inputs, but also lowers their borrowing costs, thus strengthening their economies in a sort of virtuous circle.
Some analysts point out that investors should now focus on the “reflation trade” – that is, betting on a global economic recovery based on very strong growth in less developed economies, and a weak dollar will enhance this trend.
Theoretically, if Biden’s relief package and vaccine rollout do lead to a stronger recovery than currently expected in the U.S., Inflation will accelerate and the Fed is likely to make a slightly stronger noise, at which point we could well imagine the dollar’s downtrend being reversed.
But Roach predicts that the imbalance between supply and demand for dollar liquidity will become more pronounced in the coming period due to the lack of savings and massively increasing deficits in the U.S. – especially the country’s growing trade deficit.
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