Is the end of the strong dollar policy at hand?

Thought of the day

by Chief Investment Office 25 Jan 2018

The dollar had its worst day since last June on 24 January after US Treasury Secretary Steve Mnuchin said that a weak dollar was good for the US economy because of its impact on trade. The dollar Index fell 1% and every G10 currency rallied at least 0.50% against the USD. Mnuchin’s comments suggest a possible break from the Treasury’s “strong dollar” position, a policy mainstay since the late 1990s.

While Mnuchin’s rhetoric has added to downward pressure, we believe economic fundamentals remain the primary driver behind the greenback’s decline:

  • Incremental monetary policy shifts are likely to continue to weigh on the USD. We expect the European Central Bank to signal its intention to start withdrawing monetary stimulus this quarter, while we see the Federal Reserve maintaining its current pace of stimulus removal.
  • The dollar remains overvalued against many of its major peers. For example, on a purchasing power parity basis, we estimate a EURUSD fair value of 1.28.
  • Negative current account dynamics add to pressure, while on the capital account, a surge in US external indebtedness to multi-year highs may require a rebalancing of its net international investment position (NIIP). By UBS estimates, this would necessitate a 6-10% dollar depreciation over the medium term to affect the relative value of US versus non-US assets.

Mnuchin is pushing at an open door, in our view. Later attempts by both him and Commerce Secretary Wilbur Ross to downplay the remarks failed to spark a USD recovery. We expect the currency to remain under pressure in the near term, with our three-month EURUSD forecast at 1.25.

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