In the first quarter of 2019 I expected the Dollar to turn lower against its major peers. Many factors were taken into consideration back then, including weaker economic prospects, dovish Federal Reserve, end of fund repatriation by US firms, and widening twin deficit. However, none of these factors were enough to end the King Dollar’s rally.
As we entered the fourth quarter of the year, the trade-weighted Dollar Index as measured by the Federal Reserve reached a record high of 131.57, surpassing the peak reached in 2002.
Two 25 basis points rate cuts by the Federal Reserve in August and September didn’t seem sufficient to scare off the Dollar bulls. The fact that US Treasuries bonds continued to provide some income compared to other developed economies may be one of the reasons, given we are living in a world where more than $15 trillion of debt is trading at a negative yield.
Another factor that helped to keep the Dollar strong in 2019 is the economic conditions. While few may disagree that we’re near the end of the economic cycle, the US economy continues to outperform its developed peers, and hence more inflows went into US’ capital markets.
The strong Dollar is not only harmful to US exports, but it’s also terrible for the global economy. Global debt is now estimated to be more than $246 trillion, with a large chunk of it denominated in US Dollar due to the currency’s role in global reserves. Emerging markets are the ones to suffer the most from a broadly stronger Dollar as corporates issuing and servicing their Dollar-denominated debt struggle with rising currency.
Looking forward, the Fed seems ready to restart expanding its balance sheet by purchasing short-term US Treasury bonds to prevent the recent disruption in overnight repo markets. Although Fed Chair Jerome Powell doesn’t like calling this operation as quantitative easing, markets may still consider it as a new round of QE.
In terms of interest rates, the chances of a 0.25% rate cut in October is looking increasingly likely and there’s also a 50% chance of another one in December. That doesn’t seem like an insurance rate cut as Mr. Powell has claimed previously, but rather a prolonged phase of easing monetary policy.
If this doesn’t bring the US Dollar lower, expect the US Treasury Department to flex its muscles. President Trump has been calling for a weaker Dollar for many months, but he didn’t get what he wished for yet. If the Fed doesn’t start printing money, expect Trump to order the Treasury Department to intervene through buying foreign currencies with its Dollar reserves.
Trump is not the only one seeking a lower Dollar. There’s a bipartisan backing for the idea of taxing capital inflows to US assets. If this legislation gets through, the Federal Reserve will add a third mandate to balance the nation’s current account within five years, along with maintaining price stability and promoting full employment. While such legislation may have a negative impact on US financial assets, it would discourage speculation and reduce the demand for the Greenback, hence supporting exports and reducing the trade deficit. While I can’t conclude that the Dollar will end 2019 with a lower value, I think we’re very close to the peak, so Dollar bulls should be cautious.