Can the US Dollar stay safe?
Tom Traill & Peter Warburton - 12 March 2020
Amid the mayhem of the past couple of weeks, while US Treasuries have become an ever more crowded trade, the US Dollar has surrendered some of its prior gains. As US bond yield spreads have narrowed to Europe and Japan, the US currency has struggled to hold its ground. And as the US administration fumbles its way towards an effective public health response to Covid-19, concerns have deepened over its economic impact, relative to other developed nations. If the political fall-out from Covid-19 also damages President Trump’s re-election chances, then the revocation of Trump’s low tax, light regulation regime looms large on the horizon. Will a portion of the US$14tn in foreign investment that has arrived on US shores since 2011 beat a hasty retreat?
The presidential election cycle has had an uncanny relationship with the US Dollar, at least since 1984. Democratic administrations have tended to have a strengthening effect on the Dollar, and the Republicans, a weakening effect (figure 1). President Trump might wear red ties and red baseball caps, but he was once a Democrat supporter and does not hold traditional Republican views. His willingness to cut budget deals with the Democrats and his blatant disregard for prudent fiscal policy has more of a Democratic flavour.
US presidents (and politicians the world over) tend to present grand strategies in the early years of their tenure, when they have political capital to burn, but to seek shorter-term ‘wins’ in the run up to the next election. This can be seen in figure 2 below, with the Dollar tending to weaken in the first 2 years of a presidential term, and to strengthen as the next campaign trail gets underway. Covid-19 may deny President Trump that luxury.
The recent stock market swoon may not have much relevance for November’s elections, but the mishandling of a sensitive public health issue affecting the whole country is another matter. National emergencies make or break administrations. An extensive shutdown of the US economy aggravated by half-hearted policy mitigation measures could become the defining issue of the 2020 elections.
However, perhaps the die has already been cast for the Dollar. Figure 3 shows that there is a close leading relationship between the sum of the budget balance and the unemployment gap, expressed as a percentage of GDP (all data from the CBO), and the DXY US Dollar index. The policies that the current administration have followed infer a sharply lower Dollar will ensue.
What is good for Treasury bond prices may no longer be good for the US Dollar. And as deep cracks appear once more in the edifices of US shadow banking and sub-prime corporate credit, we are confident that the tide will turn in the international search for yield.
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