Is it too early to call time on the strong US dollar? | Charts that Count
FT markets reporter Colby Smith looks at the debate raging in Wall Street over the future of the greenback and whether it is finally set to weaken
Produced by Gregory Bobillot
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There's a big debate raging across Wall Street about the future of the US dollar. Is it finally set to weaken versus its peers? Or will it continue to strengthen in the coming year? Here's a chart of the US trade-weighted dollar. Now this tracks the dollar's value versus the currency of major US trading partners.
As you can see here, it has strengthened considerably versus its peers since the beginning of 2018. And it now sits at its highest level in about two decades. It's a surprising move for a few reasons. And the trend looks set to continue, much to the chagrin of President Donald Trump, who has consistently railed against the economic impact of a strong US dollar.
Now the first reason has to do with the Federal Reserve. So a big component as to why the dollar strengthened so much versus its peers in 2018 has to do with the fact that the Federal Reserve was raising interest rates, while other central banks around the rest of the world were keeping their already low rates low, or moving them even lower than that level.
What changed was in January, when the Fed made a sharp U-turn in the path of its monetary policy. Six weeks prior, we had raised rates for the fourth time in 2018. And in January it said it was actually going to consider cutting interest rates in the face of softening US economic data.
And in July, it instituted the first of three 25 basis point cuts to its benchmark policy rate. It moved in July. It moved once again in September. And then it moved once again in October. The only effect the Fed's U-turn had on the dollar was for it to strengthen versus its peers. And this was because the likes of the European Central Bank, the Bank of Japan were rolling out very aggressive stimulus packages and cutting interest rates.
And so that interest rate differential that helped to explain the strengthening of the US dollar versus its peers during 2018 persisted well into 2019. And it looks like it's set to persist again in 2020, given the fact that the Fed has recently said that it's going to put a stop to any additional easing for the time being until it sees bigger deterioration in the economic data.
And now that brings us to our second reason. Relative economic growth. Back in 2017, President Trump unveiled a series of tax cuts aimed at turbocharging the US expansion. That helped to buoy the dollar to some degree, but economists warned that the effects of those tax cuts would be short-lived, helping to build the case for a weaker dollar.
But that hasn't happened, as you can see in this chart, given the fact that growth around the rest of the world was pretty lacklustre at best. In China, for instance, the growth rate slowed dramatically, despite a series of stimulus measures put in place over recent months. And in Europe's largest economy, Germany, it was on the brink of recession. And so when you had US growth outpacing that of the rest of the world, it helps to shore up the dollar versus those other currencies.
And then there's the ongoing US-China trade war. The US dollar plays a very important role in the global financial system. It serves as a safe haven asset for investors who flock to it during times of turmoil. And that's very much been the case as the trade war between the US and China has escalated over the past 12 months.
Now recent headlines have pointed to some more positive developments on this front. But in the last week, things have taken a turn a bit for the worse. For instance, President Trump recently said that he would be willing to wait until after the presidential election next year to strike any kind of preliminary deal with China. Within the same week, he also raised tariffs on France, Argentina, and Brazil. So these trade tensions that have helped to buoy the dollar haven't gone away.
So taking this all together, the trend that has dominated since 2018 of a strong dollar looks set to persist for some time, at least. What it would take to reverse the dollar's fortunes would be a sizable progress on the US-China trade front, as well as a shoring up of growth globally. And that looks to be a tall order.