Posthaste: The mysterious case of the falling dollar — and what it means to the world

 

Good Morning!

Call it a summer mystery.

In July the U.S. dollar, aka greenback, fell by about 5%, the biggest monthly drop in more than a decade. (Last night, the dollar fell to a two-year low of 92.495, then eased up to 92.821.)

The big question is why.

Normally, the U.S. dollar gains strength during times of economic uncertainty as investors seek safer assets and weakens when risk appetite is high. This time the dollar is dropping alongside a small fall in stock markets and amid high uncertainty over the recovery of the world economy from the coronavirus pandemic.

Neil Shearing, group chief economist for Capital Economics, says several theories have been advanced.

Some think the greenback’s weakness is just the flip side of a strong euro “which has benefitted from signs that European policymakers are finally getting their act together.” But as Shearing points out the U.S. dollar has weakened against other currencies as well, not just the euro.

Others believe we may be seeing the demise of the dollar as the world’s reserve currency, hastened by political dysfunction in America, growing tensions with China and massive money-printing by the Fed. But Shearing thinks this theory is “wildly overdone” as there currently exists no credible alternative to the dollar as a reserve currency. Moreover, the tensions between China and the U.S. have set back the internationalization of the renminbi, the only plausible rival to the dollar, and may actually strengthen the dollar’s position.

A more intriguing explanation, Shearing says, is the curious case of inflation expectations. Bond markets reflect that these have risen in most countries over the past month, but it’s particularly apparent in the U.S. Since nominal yields on U.S. Treasuries have remained steady, the inflation expectations have caused a drop in U.S. real yields, and this may have weighed on the dollar, he said.

The rise in inflation expectations, which normally comes with a rally in stock markets and signals optimism about the economy, is a bit of a mystery itself.

Shearing says one explanation may be speculation of a “regime shift in the U.S. that tolerates – or indeed targets – higher inflation.”

Though U.S. Federal Reserve chair Jerome Powell said nothing of this in his remarks following last week’s FOMC meeting, recent statements by other Fed officials suggest the central bank is eyeing a move to “average inflation” targeting in which inflation is allowed to rise above the usual 2%.

“We suspect that the Fed’s year-long review of monetary policy, which has been delayed by the pandemic but should conclude soon, could lay the groundwork for such a shift,” said Shearing.

“Rationalizing short-term movements in currency markets is often a mug’s game. However, the prospect of higher inflation in the U.S. compared to its peers may be among the more compelling reasons for investors to bet against the dollar over the long run.”

Oxford Economics also believes the U.S. dollar is on the cusp of a “multi-year downtrend” that would be a “shot in the arm” for emerging markets and their currencies.

“The dollar is the pre-eminent funding currency that drives capital flows to EM – one need only recall the pain inflicted on EM assets from the dollar’s sudden surge in April 2018. Now, nascent signs that the dollar cycle is about to turn potentially into a multi-year downtrend should remove a major headwind for EM since at least 2013,” said Nafez Zouk, Oxford’s lead EM macro strategist.

With much of emerging market debt in U.S. dollars, a weaker greenback eases the repayment burden. And a weaker dollar also boosts world trade prospects and higher commodity prices, said Zouk.


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*LAND BACK LANE* Ontario Provincial Police officers talk to indigenous protesters on Sixth Line near Caledonia on Wednesday. Earlier in the morning, a large contingent of police removed protesters occupying a nearby residential construction site, prompting supporters from the nearby Six Nations of the Grand River Territory to arrive. The protesters had moved into the construction site in tents and renamed the survey 1492 Land Back Lane. Brian Thompson/Brantford Expositor/Postmedia Network


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Vancouver’s housing market is working its way back to “normal,” the latest numbers show in this chart by BMO Economics . Home sales in this pricey city leapt 22% in July from the year before and new listings grew 28%, suggesting the market is reopening after the pandemic lockdown. Prices also rose 4.5% year over year. Senior economist Robert Kavcic said BMO predicted from the beginning that the market would surprise to the upside. “The reality is that job losses have been much more muted in higher-paying industries where homebuyers (as opposed to renters) reside; interest rates have plunged to record lows; and, supply is scarce just as preferences are shifting toward larger lots,” he said.




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* Today’s Posthaste was written by  Pamela Heaven (@pamheaven), with files from The Canadian Press, Thomson Reuters and Bloomberg.

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