The dollar has seen a major peak, topping out a cycle that began in 2011 and setting up a period of “messy” market action as exceptional U.S. economic performance fades, according to a top macro strategist.
“The U.S. economy remains exceptional of course, but as it slows and rate differentials with other countries narrow, the dollar is set to fall back. In real effective terms, it remains today as strong as it was at the peak of the Asian crisis over 20 years ago, and in the post-Volcker/Reagan era, has only been stronger, briefly, in the summer-autumn of 2022,” said Kit Juckes of Societe Generale, in a Wednesday note (see chart below).
“The rest of 2023 is likely to be messy, as signs of a turn in the U.S. economic cycle come and go, and as we watch to see how much the global economy is set to slow in the months ahead,” Juckes wrote, with the dollar then likely to weaken in 2024.
The ICE U.S. Dollar Index
DXY,
a measure of the currency against a basket of six major rivals, surged off 2023 lows set in late July as Treasury yields soared, hitting a 2023 high in early October.
The dollar rally, alongside the surge in yields, was blamed for much of a sharp pullback by U.S. stocks, with the S&P 500
SPX
and Nasdaq Composite
COMP
falling into correction territory as they retreated from late July highs. The Dow Jones Industrial Average
DJIA
turned negative on the year.
The dollar index has subsequently retreated around 5% as yields fell again and investors began to pencil in the potential for Federal Reserve interest rate cuts in 2024. With bond yields pulling back, stocks have bounced sharply, with the S&P 500 has advanced more than 6% over the past seven sessions.
It’s the period since 2020 that has been particularly exceptional, Juckes noted. The dollar weakened as the Fed eased monetary policy and fiscal stimulus by the U.S. government during the pandemic took the trade deficit to around $1 trillion.
But then a combination of massive, excess household savings, the economic reopening and a labor market tightened by the pandemic forced the Fed to tighten monetary policy more aggressively than expected, even before Russia’s invasion of Ukraine delivered an energy shock that proved dollar-friendly thanks to the U.S. shale revolution, the strategist explained.
The dollar rallied as the Fed raised interest rates further than other developed market central banks — with the exception of the Reserve Bank of New Zealand, which started earlier and hiked just as much, he said, with the dollar reaching its peak in 2023 only for China’s economic slowdown to give the U.S. economy another relative gain.
Now, the interest rate hikes are over, Juckes said, and the economic landing, “soft or otherwise, is arriving and exceptionalism, like everything else, doesn’t last forever.”
That doesn’t mean the end of the global financial order built on the U.S. dollar system, Juckes said. The post-World War II dollar order will survive for decades, he said, in part because without the U.S., the world would be left with far too much savings and far too few borrowers.
That said the dollar system is weakened, and “slower growth, toxic domestic politics, fractured global politics and the need to shift away from extraordinary U.S. fiscal largess are easily sufficient to reverse a sizeable part of the 44% real appreciation the dollar achieved between 2011 and 2022,” he wrote.
See: Why Washington and Wall Street are worried about the ‘de-dollarization’ threat
Read the full article here