US Dollar Weakness

At a glance

COVID-19 triggered swings in the US dollar. The currency gained in the early stages of the pandemic on surging demand for liquidity. When the Fed provided liquidity, the US dollar declined steadily. Since July, the currency has remained range-bound and we see reasons why, in the near term, this will continue. But we believe the drivers for a weaker dollar remain in place and we expect the currency's depreciation to resume over the long term.

    Where next for the US dollar?

    The US dollar fell over the summer and then stabilized at lower levels. In the near term, we believe the worst of the dollar’s fall has passed. Market positioning data suggests speculative traders are already short the dollar, limiting the potential for further selling. Based on CFTC data, net short positions in the dollar held by speculative accounts increased to their highest levels in nine years in September, and have remained elevated since then. In addition, we expect a US fiscal stimulus package to be passed despite recent delays, and this should also provide near-term support for the USD.

    But we do expect dollar depreciation to resume into next year. The dollar's safe-haven appeal is likely to fade as the COVID-19 situation become less worrisome if, as we expect, a vaccine is developed. That would boost investor and consumer confidence. Additionally, while a US stimulus would be a short-term benefit for the USD, in the longer term US fiscal spending should be positive for currencies that profit from risk-taking, like the euro or the pound.

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    We also see longer-term reasons for dollar weakness:

    • The ultra-loose fiscal and monetary policy in the US, which has eroded the dollar’s interest rate advantage, is set to persist.
    • Even after the election, uncertainty about the US fiscal stance and the extent of US indebtedness might continue to weigh on the USD. A strong Democratic win would bring new policy priorities, which in our view might lower the incentives to save in the US and therefore weaken the currency.
    • Prior to the COVID-19 crisis, many long-term investors had exceptionally high levels of USD exposure, to benefit from the wide interest rate differential between the US and other funding currencies such as the Swiss franc and the Japanese yen. We expect this overexposure to be addressed.

    So tactically we think investors should sell the USD into its rallies due to its longer-term downtrend. Investors should look at their strategic positioning and reconsider it if necessary. We see a number of ways to position for a weaker greenback:

    Diversified set of G10 currencies. We think USD short exposure should be implemented against a broadly diversified set of G10 currencies. We see medium- to long-term upside potential in the EUR, GBP, CHF and the AUD. Apart from these, the Scandinavian currencies and the NZD and CAD also have some upside potential.

    Asian high-yielding currencies. In FX, we prefer Asia Pacific currencies with a high yield (Indian rupee, Indonesian rupiah) and cyclical exposure (Singapore dollar) to those that are richly valued (Australian dollar) or low yielding (Taiwanese dollar), as well as the US dollar, where we expect further long-term depreciation.

    Gold. Declining real yields have been the primary driver of the rising price of gold, which is one of the best-performing assets this year. We expect a further fall in real yields to underpin gold. But gold is typically also inversely linked to the US dollar, and we believe the metal will benefit from a longer-term depreciation of the currency. Finally, US-China tensions continue to simmer.

    Talking points:

    • In the near term, we think the worst of the dollar’s fall has passed.
    • Longer term, we expect the currency to be undermined by the reduction in the US rate advantage, political uncertainty, worries over US indebtedness, and a shift out of long-term USD holdings.
    • We see three primary ways to position for this: a diversified set of G10 currencies, Asia high-yielding currencies, and gold.

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