Do not write off the dollar yet

Article about Do not write off the dollar yet

Aug 14, 2020

Dollar drop

Since the bottom of March, the S&P 500 index has returned to pre-coronavirus levels. In the same period, the dollar underwent an opposite movement. The world's main currency lost 11% against the euro during this period. Such a fall in such a short period of time is remarkable on the foreign exchange market. After all, with a daily trade of 5000 billion dollars, the global currency market is much larger in size than, for example, the stock market. Most of this trade takes place in the US dollar and can have major consequences on the financial markets.

Reasons for the fall

See, for example, the rise in the price of raw materials quoted in dollars. Not only gold and silver but just about all commodities rose. Gold even recently recorded a New All-Time High. The fall of the dollar has attracted the attention of many analysts. The consensus expects further progress of the fall, based on the same factors which have been at the basis of the price fall until now. The fear of new lockdowns in the United States as a result of the rising number of corona infections, the damage this will have to the economy and the broad monetary policy of the central bank to support the economy and the stock markets. The budget deficit, which has risen to unprecedented proportions to 3400 billion dollars and government debt of over 132 percent of GNP, do not speak in favour of the dollar either.

Will the decline continue?

However, it is very questionable whether the dollar has begun to fall for a long time. The causes of the decline seem to be all coming to an end. For example, the increase in the number of new Covid-19 infections in the United States seems to be decreasing. The macro-economic figures in the United States appear to be falling. For example, most companies in the United States have so far reported better than expected results for the second quarter. And, not unimportantly, the interest rate differential between the United States and the European Union has narrowed considerably as a result of the Federal Reserve's generous monetary policy. On more than one occasion, the central bank has indicated that it does not think about a negative interest rate. A further reduction, therefore, does not seem to be on the horizon for the time being. Meanwhile, the most positive momentum resulting from the recently approved support package in the European Union has been incorporated into the euro exchange rate. On top of this, the number of contagions in the European Union now also seems to be increasing again. The relative advantage of the euro against the dollar is therefore declining.

Stress on the stock markets

Most important, however, is the role that the dollar keeps playing on the financial markets "when the going gets tough". Historically, the dollar invariably increases in value as soon as the stress on the stock markets increases. This was the case during the credit crisis and was again evident during the first phase of the coronavirus outbreak. The dollar reached its provisional peak exactly at the time when the stock exchanges were bottoming out worldwide. In the subsequent relaxation on the markets, the value of the dollar as a favourite refuge fell again. Other havens such as gold, silver and technology funds replaced it.

Safe Haven

In the long term, the huge budget and trade deficits will undoubtedly affect the dollar. However, the dollar's position on the foreign exchange market is still very strong. Bear in mind that a daily trade deficit of $1.6 billion is quite a bit out of proportion with a daily turnover of $5,000 billion on the foreign exchange market. According to the Bank for International Settlements (BIS), no less than 88 percent of daily currency trade runs via the dollar. Now that the stock markets are back to the level they were before the outbreak of the virus, the economic recovery is beginning to lose momentum and the infections in the European Union are starting to mount up again, it is not excluded that the dollar will soon regain its position as the world's most popular haven of refuge.

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Articles authored by Robert Jan Teuwissen

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