Skip to content
the patient investor

the patient investor

  • Model Portfolios
    • Model Portfolios
    • Our Strategy
    • Investment Allocation
    • Australian Growth: Performance Dec-2022
    • International Growth: Performance Dec-2022
    • Sample Updates
    • Mortgage Investments
  • Market Analysis
  • Macro Trends
    • Global population
    • Environmental damage
    • Decarbonization
      • Energy: The coming crisis
      • Lithium
    • Internet
    • Digital communication
    • Automation
    • Health care and medical science
    • Debt & Inflation
    • Globalization
    • Geopolitics and great power conflict
  • About
    • Colin Twiggs
    • Financial Services Guide
    • Terms of Use
    • Privacy Policy
    • Contact Us
  • Subscribe
  • Login
Posted on February 23, 2018 by Colin Twiggs

Why is the Dollar falling?

The broad, trade-weighted US Dollar index has been declining since early 2017.

US Dollar Index - Broad and Major Trading Partners

This is the best explanation I have found for current US Dollar weakness. From Bank of Montreal, BMO Nesbitt Burns:

The relationship isn’t perfect, but as a general rule of thumb, the USD declines in years when global growth is above potential. In such years, strong global growth causes commodity prices to rise, which lifts commodity currencies. In addition, strong global growth normally triggers a flood of investment out of developed economies and into emerging economies. As emerging central banks intervene to slow the appreciation of their currencies from these two factors, they sell the USD against EUR and other alternative reserve currencies, thereby causing the USD to decline against both developed and emerging currencies. That dynamic helps explains the USD depreciation in 2017 as well as the 2004-2007 period. The 10Y average of the IMF’s World GDP growth rate is 3.4% and we think that is roughly potential growth. The IMF estimates that global growth will come in at about 3.6% for 2017 and accelerate to 3.7% in 2018.

In addition, the US’s twin deficit fundamental (sum of the current account deficit and fiscal or federal budget deficit as shares of GDP) is another factor that is negative for the USD. Turns in the twin deficit normally precede turns in the USD by 1-2 years and then trends match thereafter. The US’s twin deficit fundamental has been deteriorating for the past two years and is likely to deteriorate further in 2018 and beyond due in part to the tax cuts. When looking at all these factors together with the fact that USD phases tend to last 5-7 years, we feel that we have to forecast a continuation of broad USD weakness—albeit at a slower pace. We project that the broad USD index will fall 1.5% in Q1 and then 1.0% per quarter in each of the remaining three quarters of 2018.

Hat tip to David Llewellyn-Smith at Macrobusiness.

The fall in the Dollar may also be self-reinforcing, as Enda Curran at Bloomberg highlights:

…..On top of the boost already coming from robust global GDP growth, the dollar’s fall over the past year may add over 3 percent to the level of world trade, according to Gabriel Sterne, global head of macro research at Oxford Economics Ltd. Tipping further dollar weakness, the risks are skewed to the upside for Oxford’s baseline forecast for 5 percent growth in world trade in 2018.

“Falls in the value of the dollar oil the wheels of the global financial system, boosting global liquidity by strengthening balance sheets and alleviating currency mismatches,” Sterne wrote in a note. “One important channel is variation in the differential between the cost of raising dollars onshore and offshore. Dollar weakness reduces the cross-currency basis, increases cross-border lending and boosts bank equities.”

The biggest winners will likely be emerging economies given the weaker dollar will lower the value of their dollar-denominated debt, taking pressure off their balance sheets and from credit conditions more generally…..

Finally, from Deutsche Bank (again hat tip to David):

How can it be that US yields are rising sharply, yet the dollar is so weak at the same time? The answer is simple: the dollar is not going down despite higher yields but because of them. Higher yields mean lower bond prices and US bonds are lower because investors don’t want to buy them. This is an entirely different regime to previous years.

Dollar weakness ultimately goes back to two major problems for the greenback this year. First, US asset valuations are extremely stretched. As we argued in our 2018 FX outlook a combined measure of P/E ratios for equities and term premia for bonds is at its highest levels since the 1960s. Simply put, US bond and equity prices cannot continue going up at the same time. This correlation breakdown is structurally bearish for the dollar because it inhibits sustained inflows into US bond and equity markets.

The second dollar problem is that irrespective of asset valuations the US twin deficit (the sum of the current account and fiscal balance) is set to deteriorate dramatically in coming years. Not only does the additional fiscal stimulus recently agreed by Congress push the fair value of bonds even lower via higher issuance and inflation risk premia effects, but the current account that also needs to be financed will widen via import multiplier effects. When an economy is stimulated at full employment the only way to absorb domestic demand is higher imports. Under conservative assumptions the US twin deficit is set to deteriorate by well over 3% of GDP over the next two years.

US Current Account Deficit

In summary:

  1. Rising global growth boosts commodity prices and emerging markets
  2. Central banks in emerging markets then sell Dollars to slow appreciation of their local currency
  3. Fiscal stimulus, such as US tax cuts and infrastructure spending, lifts inflation
  4. Higher inflation causes a bond bear market
  5. Fiscal stimulus also widens the current account deficit
  6. Central bank selling, higher inflation, a bond bear market and wider current account deficits all cause a weaker Dollar

Share this:

  • Click to share on Twitter (Opens in new window)
  • Click to share on Facebook (Opens in new window)
  • Click to share on LinkedIn (Opens in new window)

Related

CategoriesCommodities, Deficit Spending & Employment, Inflation, Investment & Infrastructure, US & Canada, US Dollar Index Tagsbond bear market, current account, emerging markets, fiscal budget, Inflation, twin deficits, US Dollar

Post navigation

Previous PostPrevious Benjamin Graham: The intelligent investor…..
Next PostNext Richard Koo: Surviving in the Intellectually Bankrupt Monetary Policy Environment

Login for the latest Market Analysis

  • Debt default and currency devaluation
  • Michael Pettis: The China Shock is Coming
  • US GDP slows as bear signals grow
  • Australia: Three more rate hikes
  • A bear market for bonds?
  • ASX sector performance
  • ASX 200 and S&P 500 diverge
  • Retail sales + low unemployment = more rate hikes
  • CPI eases but outlook still bearish for stocks
  • Gold rises as the Dollar falls
  • Stocks rally on strong jobs report
  • Core PCE Inflation, Paul Volcker and the Copper price
  • Falling Home Sales Warn of Slowing Economy
  • Fedex slumps
  • Nouriel Roubini: “We are in a debt trap”
  • US Building Permits Plunge
  • Our 2023 Outlook
  • Will slowing inflation force the Fed to halt rate hikes?
  • Have stock prices lost touch with reality?
  • Australia: Hard times
  • Gold, the Dollar and inflation
  • Crude oil falls
  • Larry Summers | More rate hikes, no soft landing
  • Gold rallies but needs to backfill
  • Slow motion train wreck revisited – Part II
  • Chairman Powell’s speech
  • Slow-motion train wreck revisited – Part I
  • How Australia should prepare for a Chinese invasion of Taiwan
  • ASX double-bottom breakout
  • Australia’s debt end game

Topics

@Colin_Twiggs on Twitter

My Tweets

Disclaimer

Colin Twiggs is director of The Patient Investor Pty Ltd, an Authorised Representative (no. 1256439) of MoneySherpa Pty Limited which holds Australian Financial Services Licence No. 451289.

Everything contained in this web site, related newsletters, emails, discussions, training videos and conferences (collectively referred to as the “Material”) is intended for the purpose of teaching analysis, trading and investment techniques. Advice in the Material is provided for the general information of readers and viewers (collectively referred to as “Readers”) and does not have regard to any particular person’s investment objectives, financial situation or needs. Accordingly, no Reader should act on the basis of any information in the Material without properly considering its applicability to their financial circumstances. If not properly qualified to do this for themselves, Readers should seek professional advice.

Investing and trading involves risk of loss. Past results are not necessarily indicative of future results.

The decision to invest or trade is for the Reader alone. We expressly disclaim all and any liability to any person, with respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance upon the whole or any part of the Material.

Please read our Financial Services Guide.

© Copyright 2016 - 2023 The Patient Investor Pty Ltd. All rights reserved.
Powered by WordPress / WordPress Theme by WPSmart