A heavy outlook for the US Dollar

The US Dollar Index has sunk to a 22-month low and registered its fourth worst three-month return in a decade as of 24 July. The relentless spread of Covid-19 across the US and improving risk sentiment elsewhere is crimping demand for the safe-haven reserve currency. Interest rates suggest there could be more depreciation to come.


The dramatic collapse of the US dollar’s interest rate advantage over the rest of the world removed a key support for the currency. The average yield on US Treasuries is now in line with that of other government bond markets, after years of yielding much more. With leading economic indicators rebounding from their recent lows, investor risk sentiment has been given a boost, further denting the demand for the safe-haven currency.

The problem for the dollar is that its long-term fundamentals are poor. The large scale of debt monetisation in the US will continue to depress interest rates, keeping downward pressure on the dollar. Even before the global health crisis, the US had a 5.9 per cent cyclically-adjusted deficit in 2019, vs. the Eurozone’s 1.1 per cent. This likely limits the scope for US economic growth outperformance in the coming cycle.

Dollar depreciation has also been driven by a resurgent euro, which represents over half of the dollar index. Last week’s agreement among European Union leaders on the shape of the €750 billion recovery fund appears to be another game-changing ‘whatever it takes’ moment, spurring confidence in the region’s assets. However, the euro is close to a two-year high, so perhaps most of the good news is already priced in.

Even if risk sentiment was to turn, we think the Japanese yen might be a better option for safety now that the yield disadvantage is less prohibitive. The yen offers better value in terms of purchasing power parity and Japan has suffered less from the global health crisis so far.