Escalating political and health risks in the US and rising optimism about the global economic recovery should keep the dollar sliding over the next few months, according to analysts.
Large banks turned bearish on the greenback in late May, citing drastic cuts in interest rates and a flood of liquidity unleashed by the Federal Reserve, as it tried to alleviate the economic effects of the pandemic.
Since then, the outlook for the dollar has deteriorated further, strategists say. They cite growing concerns over the reopening of the world’s largest economy in the face of a steady increase in Covid-19 cases, as well as increased political threats and a hit from investors exiting safety-seeking bets in the dollar.
Against a basket of other currencies, the US dollar has slipped 0.7 per cent since the start of July, inching lower against both its developed and emerging markets peers, following a 0.4 per cent fall in June. It is now more than 6 per cent below the peak it reached in late March.
“The stars have aligned for the dollar to weaken more,” said Shahab Jalinoos, global head of foreign exchange strategy at Credit Suisse. “The US simply faces more risks than other major economies at this point.”
European economies have cautiously reopened, while progress towards the creation of a giant European recovery fund has boosted the prospects of the euro. Chinese stock markets have also been rallying, along with the renminbi.
Since the US rolled back some restraints on movement, economic data have rebounded but coronavirus infection numbers have also surged in many states. Last week the US recorded its biggest one-day increase in cases since the start of the pandemic.
That is likely to prompt further restrictions and less solid economic numbers, said George Saravelos, global head of currency research at Deutsche Bank. “We argued a key driver of a weaker dollar in coming months is likely to be negative macro data surprises from the US,” he said.
Political risks have also risen for the dollar. Congress has until the end of the month to approve an extension to its emergency unemployment benefit programme. Mr Jalinoos said a failure to extend it could inflict a “lot of pain” on the US economy in the run-up to presidential elections in November.
Already, investors have begun to position for the possibility that Democratic candidate Joe Biden could bring an end to the presidency of Donald Trump after a single term. Mr Trump continues to trail Mr Biden by about 20 points in betting markets, amid broad dissatisfaction over his handling of the pandemic.
A strong showing for the Democrats would probably be negative for the dollar too, said Mr Saravelos, noting that the US currency tends to strengthen while outlooks are uncertain and weaken when global growth is stronger.
A Biden win would “shift away from tariff policy and diplomacy by random tweet,” he said.
There are also signs that demand for the dollar as a haven asset is easing. In March, a severe shortage of dollars amid a global surge in demand prompted the US central bank to open swap lines with more than a dozen peers in the developed and emerging world.
But last month, in a sign that markets were returning to a more even keel, four big central banks decided to scale back their use of the facility. Recent data showed central banks holding just $153bn of outstanding loans from the Fed, down from $449bn on May 27.
Finally, analysts note that the US currency also lost its yield advantage when the Fed cut rates in mid-March, slashing its policy rate by a full percentage point to a range of 0-0.25 per cent, a level not seen since 2015.
As a result, the dollar is now a less attractive target for investors engaged in so-called carry trades, said Olivia Frieser, global head of markets research at BNP Paribas. Previously, many investors would borrow in very low-yielding currencies such as the yen and the euro to buy dollar assets — a trade that should now unwind, boosting the euro and yen.
Now, discussions at the Fed about so-called yield curve control, which involves the central bank setting caps on Treasury yields and intervening in the market to keep them under those limits, has also signalled to investors that rates are unlikely to rise anytime soon.
“The Fed has done everything you can usefully do to undermine your currency,” said Kit Juckes, head of forex strategy at Société Générale. “In doing so, [it] did the world an undisputed favour.”