Future of the US Dollar

Future of the US Dollar

As the Coronavirus started to wreak havoc across the world, the US dollar stepped up as the world’s de-facto currency. Risk-off sentiment drove investors and traders to the US dollar in droves, pushing the US dollar to highs not seen since 2017.

US Dollar Index

The world’s de-facto currency, making up over 60% of all known central banks’ foreign exchange reserves, saw the FED offering swap lines to central banks to provide liquidity in the market by “swapping” their currency for US dollars. However, the dollar’s strength may be short-lived as the market sentiment cautiously shift to risk-off assets.

Risk-off shown by demand for FX Swaps for the US Dollar

Thanks to the FED’s swaps, demand for the US dollar across the world have been met, restoring equilibrium in the market. This was shown in a chart from Steven Englander of Standard Chartered Plc,

There may be more headwinds for the US dollar. As we all know, everything depends on the assumption on how we emerge from the Coronavirus pandemic. If we assume that we shall see an economic recovery with the markets discounting a second wave, we should see the USD depreciate back to pre-coronavirus levels. Furthermore, there are a couple of other factors that may help the dollar depreciate

Quantitative easing increases the supply of the US Dollar

Federal Reserve’s balance sheet

With the Fed’s balance sheet swelling up to $7 Trillion, they have been loosening their limits on what assets they are willing to purchase. They have recently added corporate bond ETFs to the lists of assets they are ready to buy. With quantitative easing and stimulus comes an increase in money supply, which historically has seen the currency in question to depreciate (See Euro and the ECB in 2015, Government Stimulus in the US in 2009, and Bank of Japan in 1997)

Low rates for a longer time

“We are not even thinking about raising rates”, Jerome Powell stated at a conference earlier this month, showing that they are willing to provide accommodative financial conditions until 2022. This also means investors may want to see their money earn a return else wear where yields are relatively higher, especially in EM currencies.

Higher oil prices

Since oil transactions are denominated in US dollars, there is an inverse relationship with oil prices and the US dollar. Correctly, as oil prices increase, the pressure is put on the US dollar as producers convert more US dollars to their home currency.

If we see a promising recovery, there is a high likelihood we a sharp depreciation in the US currency. 

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