a look over the medium term

by Sean Tweedie | July 29, 2021

It is hard to believe that we are now more than halfway through this year. It has been eighteen months since the pandemic began and we are starting to see a recovery in the global economy. The Organisation for Economic Co-operation and Development (“OECD”) now projects that the global economy will expand by 5.8% this year, which is up from their March projection of 5.6%. Although vaccine rollout plans were slow for both developed and developing countries alike, they are gaining momentum. The Global Health Innovation Center at Duke University estimates that pharmaceutical companies are on track to produce more than 10 billion vaccine doses this year. See Figure 1.

Figure 1

Considering this, let’s consider what the impact will be in the currency markets. When considering the path for the dollar a simple rule begins by gauging two things. Is the global economy expanding or contracting, in other words is global growth on the rise? And how does U.S growth compare to global growth. As we have mentioned before, the dollar will tend to appreciate when the economic activity in the U.S picks up relative to the world. This is a key reason why the dollar is firmer versus its peers during recession or downturns. Looking forward the International Monetary Fund (“IMF”) predicts that growth outside of the U.S will be higher than U.S domestic growth over the next few years. A key reason for this is that most countries lagged the U.S in terms of both their vaccination programs as well as the amount of monetary and fiscal stimulus that they employed. See Figure 2. The dollar further benefited from the general uncertainty in the market as investors looked to the safe haven status of the dollar. As we continue to see optimism on global growth improve, the attractiveness of the dollar will fade.

It is interesting when drawing a comparison between the factors present during the 2000’s and today. Many of the factors which underpinned a dollar bear market are in place today.

Figure 2

  • U.S growth lagged the rest of the world. The main reason for this was the commodity boom driven by massive infrastructure spending in China. Today there is a move towards green energy. Leaders in building renewable energy infrastructure, such as Europe, could also see a boom as demand for their goods and services rise. Producer economies of metals such as copper, nickel, cobalt, aluminium, and silver will benefit. See Figure 3.
  • Following the tech bubble bust, monetary policy was extremely easy with interest rates near 1%, and fiscal policy was more accommodative than needed to close the output gap. This led to the expansion in the U.S twin deficits, a similar situation as today.
  • This created excess demand in the U.S which led to inflationary pressures where headline inflation was consistently between 2-4%. As a result, real interest rates (nominal interest rates adjusted for the effect of inflation) dropped which led to a weaker dollar. Today inflation, although perhaps transitory, is rising faster in the U.S than before. The Federal Reserve is more reluctant to normalize policy compared to its peers and so real rates outside the U.S will rise faster than in the U.S, consequently hurting the dollar.

    These past few years have been plagued by a lack of dollar liquidity. This was one of the tailwinds behind the dollar. Whenever liquidity dried up, the dollar surged. Today the situation is quite different. The Federal Reserve’s balance sheet is still expanding and injections through quantitative easing measures has seen the supply of dollars improve. The Federal Reserve has further extended swap lines with many other central banks which allows them to draw on dollar liquidity.

    Although we have seen a bounce in the dollar of late, we still need to consider the longer-term path for the dollar. If we look at the factors as they stand, we believe that we will see a global recovery in growth over the next year coupled with a depreciation in the dollar and an appreciation in the more high-risk currencies such as the rand.

Figure 3


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