The US dollar baffled Wall Street
Pandl has a âstructurally negativeâ view of the dollar over the next three years. Goldman expects the current account deficit to peak at 4.4% of gross domestic product by the end of 2021. That’s more than the median estimate of forecasters, who believe it will climb to 3.6 % of GDP this year, up from 3.09% at the end of last year and the largest since 2008.
If Goldman’s view on the greenback is correct, it would suggest that it is only a matter of time before foreign investors seek higher-yielding international assets, which would undermine the strength of the dollar and could usher in a long-term structural decline that many predict. For emerging markets, it could also mean stronger economic growth due to the US dollar’s inverse correlation with commodities, rising local stock prices and the potential deflation of dollar-denominated debt.
In the U.S. fixed income market, 10-year Treasury yields are around 1.62%, which is higher than most developed markets but significantly lower than the 3% investors get. for Chinese and Mexican bond equivalents. And while the U.S. stock market continues to hit record highs, Goldman predicts a decline in stock returns relative to non-U.S. Markets over the next year – and he expects the shortfall will also divert dollar flows.
This is not, however, a consensus point of view. Stephen Jen of Eurizon SLJ, for example, believes that US economic growth will stimulate demand for the greenback more than talk of a growing deficit and a low-yielding environment will hamper it. Bank of America agrees, saying deficits could weigh on the dollar in three to five years, but not now as the economy beats its global peers.
The key to this is recovery from the pandemic. The United States leads the major economies in vaccinating its people, paving the way for businesses to reopen. Economists predict that the gross domestic product of the United States will grow 6.5% this year, compared to an average of 5.1% for developed economies.
“A strong US economy should attract enough global capital to easily finance its large external deficit and in turn support the dollar,” Jen said. “Higher economic growth will mean more profits for US businesses and higher inflation, both of which suggest a stronger dollar.”
Those in Jen’s camp argue that when US assets are attractive to the world, the dollar has the capacity to strengthen even if the current account deficit widens. That’s because foreign investors need dollars to invest in American titans like Amazon.com, Google’s parent Alphabet, and Facebook – all of which are listed on the US stock exchanges.
It is not without precedent. In the 1990s, the US currency grew amid a growing deficit as the tech startup boom drew in just about everyone. And during the 1980s, high nominal interest rates attracted foreign investors as former Federal Reserve chief Paul Volcker raised the target rate to 20%, helping to prop up the greenback. while the current account deficit increased.
Admittedly, opponents point out that the dollar weakened when the US current account deficit widened in the mid-2000s. But Morgan Stanley says his historical analysis shows it’s not clear whether such a relationship holds in time. In a corresponding study of 28 currencies, the relationship between exchange rates and deficits was mixed, strategist Matthew Hornbach and colleagues wrote in a report.
âBecause most US trade is billed in USD, higher imports should not generate a weak dollar,â they wrote. “Rather, it will be the capital account that feeds the US dollar, that is, how will foreign investors react to the influx of dollars.”
The latest US net international investment position data shows the measure is currently the most negative on record. This indicates that foreign investment in the United States still exceeds most American investment in overseas assets.
That said, the bearish dollar at Deutsche Bank believes there is a primary reason for particular concern about the external deficit.
âIts counterpoint is a large budget deficit,â which could prove to be persistent, especially in light of the challenges of containing it in the American political system, wrote Alan Ruskin and his colleagues.
These concerns are factored into the bank’s forecast that the euro will climb to 1.30 against the dollar by the end of the year, from around 1.22 on Thursday, and end at that level in 2022. Meanwhile, leveraged investors remain bearish on the currency after moving to -long in early May. They have been bearish for 10 of the past 16 months.
âA country cannot have a high current account deficit forever,â said Athanasios Vamvakidis, head of G-10 FX strategy at Bank of America. âTo reduce it, you need a weaker currency to reduce imports and increase exports. At some point, it will happen. “
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