The US dollar has been on the slide since August, hitting a 15-year low against a basket of major trading partners’ currencies and a new record low of $1.428 against the euro. Last week it made a slight recovery, but this is likely to prove a “dead cat bounce” rather than a trend reversal, says Derek Fray on FXStreet.com.
A need to rebalance a $700bn annual current-account deficit has provided “a solid long-term case for dollar weakness”, says Lex in the FT, while the currency’s appeal has been undermined by rising interest rates abroad and “pummelled” by the recent cut in US rates. And the economy “has yet to feel the full impact of the housing slump”, implying lower US rates ahead, says Capital Economics; these look likely to fall to 4.25% by early next year. By then, the euro could have reached $1.50.
Moreover, America depends on foreigners scooping up dollar-denominated assets to plug the current-account deficit, and “the kindness of strangers” is being tested as they are being offered the prospect of lower returns (owing to lower rates) in a depreciating currency, says The Economist. “There are already some signs of strain”: Saudi Arabia did not follow September’s rate cut, prompting speculation that they may abandon their dollar peg. Meanwhile, capital flows data for July shows that demand for long-term securities slid sharply, so foreigners may be beginning to lose their appetite for US debt. Throw in worries among foreigners that inflation could erode their holdings – long-dated Treasury yields have ticked up since the Fed cut short-term rates – and a dollar rout is a possibility.
With the euro rocketing, Europe’s exporters are becoming increasingly uncompetitive; politicians are wringing their hands and the employers’ federation Business Europe says the exchange rate has reached a “pain threshold” at $1.40. Asian currencies, held down against the dollar by authorities trying to bolster exports, remain undervalued against the euro; indeed, the yuan has fallen over 5% against the euro in the past two years.
“At some point, European exporters will find the US market closing, while Japanese and Chinese exporters become increasingly ferocious competitors in the EU market,” says Breakingviews’s Martin Hutchinson. Political pressure for a managed exchange-rate system to push the yen and the yuan up against both the euro and the dollar is mounting. Given this backdrop, the 20 October gathering of G7 finance ministers seems likely to prove unusually newsworthy.