The U.S. dollar is heading for a drop towards the end of this year, according to strategists, in what would mark a reversal from a record-breaking surge when coronavirus first washed over markets.
The world’s most important currency shot higher in March, reaching its strongest ever point when stock and bond markets suffered the most intense phase of the pandemic’s impact. A month later, the dollar — widely considered a haven in times of stress — remains unusually strong.
But some analysts and investors are confident that the tide will soon shift, after central banks around the world acted to ease the flow of dollars around the financial system. Big cuts in U.S. interest rates, which are much larger than those in other big economies, are also likely to drag down the dollar in the coming months, they say.
“The most bearish outcome for the dollar is that the global economy recovers as expected and the (U.S. Federal Reserve) stays dovish,” said Eric Stein, a portfolio manager at Boston-based Eaton Vance. “We are seeing some of the conditions for a weaker dollar slotting into place.”
Investors, companies and households hoarded dollars in late February and early March when the viral outbreak prompted economic lockdowns and imposed a hard stop on corporate revenues.
That funding stress eased after the Fed installed or revived swap lines with 14 other central banks, helping currencies such as the euro and sterling to recover some ground. The U.S. central bank quickly followed up with a new facility that allows international monetary authorities to temporarily swap their holdings of U.S. Treasury bonds for dollars.
Despite all that, the dollar is still nearly 10 per cent higher against the Australian dollar and 25 per cent stronger against the Mexican peso than at the beginning of the year. On a trade-weighted basis it is at a three-year high.
That poses a risk to governments and companies worldwide that have borrowed in dollars and now face a tougher time repaying those debts.
“There is so much dollar debt outside the U.S. globally, that policymakers around the world want to make sure that the currency doesn’t strengthen further,” said Stein.
The dollar can probably remain elevated for now, due in part to bursts of nerves that tend to support the currency. Goldman Sachs analysts said they continued to favour the dollar against the euro, for example, over the short term.
But the Fed’s aggressive response to the crisis could lead to a weaker dollar by the end of the year, said Mark McCormick, global head of foreign exchange strategy at TD Securities.
“We’ll see a market top . . . in the next couple of months as the Fed story overrides the dollar,” he said.
Before the pandemic spread the U.S. had the highest key interest rates among developed economies, which supported the dollar as investors sold currencies with negative rates such as the euro to buy the greenback and profit from higher yields.
But after coronavirus struck, the Fed delivered two emergency rate cuts in quick succession to about zero, as well as announcing interventions in markets for U.S. Treasuries, agency mortgage-backed securities, commercial paper and corporate debt, among others.
Other central banks, such as the Bank of England, Bank of Canada and the Reserve Bank of Australia, followed suit and cut key rates to near zero. By eliminating interest rate differentials, central banks have wiped out carry trades and put longer-term valuations in focus, said Ugo Lancioni, head of global currency at Neuberger Berman.
“There is no doubt that activity will bounce back after the lockdown, but the damage has been done and it’s the governments that are picking up the bill, which means debt to GDP moving significantly higher globally,” he said.
According to projections from the IMF, global public debt will rise from 69.4 per cent of national income last year to 85.3 per cent in 2020. But the increase is more pronounced in the U.S., where the IMF said the public sector deficit was set to nearly triple while public debt was set to rise to 107 per cent of national income.
There is so much dollar debt outside the U.S. globally, that policymakers around the world want to make sure that the currency doesn’t strengthen further
“The U.S. is being the most aggressive with easing and government spending and as a result we expect to see the biggest deterioration in public finances there,” said Mathieu Savary, a strategist at BCA Research.
Savary expects the euro to trade at US$1.15 by the end of the year, up from US$1.08 now. The pound’s recovery could be even sharper, according to Thomas Flury, a strategist at UBS Wealth Management. He expects sterling to trade at US$1.33 by the end of June and at US$1.40 by year-end, from US$1.24 now.
Bank of Montreal says the Canadian dollar would remain resilient against the greenback at around 71 U.S. cents but could fall below 69 U.S. cents. By the second half of the year, the currency would settle in that range, but would be challenged to get back above the 75-cent level even in 2021.
© 2020 The Financial Times Ltd.
With a file from Financial Post Staff