Three reasons why the US dollar isn’t king

Thought of the day

by Chief Investment Office 16 Mar 2018

President Trump’s newly appointed chief economic adviser Larry Kudlow has wasted no time in giving his opinions on the US dollar. Kudlow would like to see the US currency a “wee bit stronger” and said “I would buy King dollar.”

His comments helped stabilize the USD this week, which is up 0.5% versus the euro over the past three sessions. But we see reasons why Kudlow could become a disappointed dollar bull:

  • The US current account deficit and growing fiscal deficit will need financing. Fiscally stimulating an economy at full employment is likely to suck in imports, widening the trade deficit and exacerbating the problem. The need to attract capital is one reason why yields have risen and could also require a cheaper dollar.
  • On the capital account, because of persistent current account deficits, US external indebtedness is rising rapidly. US net liabilities are now more than 40% of GDP, a record. To help stabilize the position, we estimate a 6–10% (broad) USD depreciation is needed over the medium term.
  • The strength in the global economy favors the currencies of exporting regions, such as the Eurozone, and our base case is that trade tensions will not escalate to significantly disrupt global trade flows. The forthcoming end to the ECB's QE program further supports the euro.

So we expect verbal support for the USD will prove short-lived. We expect the USD to weaken further and forecast EURUSD will reach 1.25 over three months, 1.28 over six months, and 1.30 over 12 months. The risks to our view are a sudden rise in US inflation, which could prompt faster rate hikes, and/or a sudden slowdown in global growth.

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