Despite the US Treasury refraining last week from naming any major trading partners as currency manipulators, President Donald Trump on Monday tweeted that “Russia and China are playing the currency devaluation game as the US keeps raising interest rates. Not acceptable!”
But Trump’s comments fly in the face of broad USD weakness. The US Dollar Index has fallen 9% since Trump’s election victory. The yuan has appreciated by 7.5% against the USD over that period, while until sanctions were imposed on Russian oligarchs earlier this month, the ruble had appreciated by 9%. Fundamentals, not political comments, have driven this trend and, despite interest rate support, we expect further USD depreciation.
- 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. Net US liabilities are now more than 40% of GDP, a record. To help stabilize the position, 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 disrupt global trade flows much.
Overall we look for further USD weakness. We prefer the euro and the Canadian dollar to the USD and forecast EURUSD at 1.30 and USDCAD at 1.22 over 12 months.
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