Shifting Gears: US Dollar on a Downward Trajectory
We believe the US dollar saw its peak in the current nine-year valuation cycle in March 2020. The global outlook for persistent near-zero interest rates and the open-ended commitment to quantitative easing favor a US dollar bear market. Election risks and prospects for increased US regulations and taxes add to the burden on the greenback. However, the US dollar is unlikely to lose its reserve currency status even as such fears may trigger volatility.
The outlook for the US dollar changed in July, evidenced by the 4% drop in the greenback versus the G10 basket during the month. To add some historical perspective, the US dollar typically loses around 3%-4% per year for 7 to 10 years in a bear market cycle – we experienced that change in one month. What explains this change?
In our view, investors began to recognize the implications from the resurgence of COVID-19 – the likelihood of a protracted and uneven economic recovery and an outside chance for the loss of the US dollar’s dominance as a reserve currency. In short, the longer-term dynamics and interest rates have shifted to favor a US dollar bear market and the economic and election headwinds have accelerated that shift. Our case is as follows:
US Dollar Started From a High Point
The US dollar tends to move in 7-10-year cycles, which produce broad swings of at least 30%-40% in the currency’s value. The latest bull market entered its tenth year in 2020 and reached a peak in March, posting a 40%-plus gain from its 2011 low in the Bloomberg Dollar Index. The duration of the cycle plus the pattern of historically low interest rates (prior to the virus) meant that the US dollar was expensive relative to its long-run fair value. In a nutshell, relative interest rates already favored a US dollar peak with the risk of a looming bear market.