The dollar's summer slump
The FT's capital markets editor Katie Martin looks at the currency markets after the dollar suffered its worst month in July in 10 years
Produced by Petros Gioumpasis
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The US dollar is down in the dumps. The dollar index, which tracks its value against a basket of six other major currencies, has been falling now for four months or so. That's its longest decline in three years. July was the worst month for the dollar in 10 years. So what's going on?
It's actually a little bit difficult to say. There's a few reasons why the market might be a bit nervous about the dollar right now. One is the speed and force with which the US economy is managing to emerge from the coronavirus crisis. You can argue that other parts of the world are making a slightly slicker job of it. The other is that there is no small matter of the US presidential elections coming along in November. But none of these things does a particularly good job of really explaining why the currency's been in such a decline.
One thing to bear in mind is that currencies can't fall in a vacuum. They have to fall against other currencies. And one currency that's been having a particularly good run recently is the euro, which makes up a large part of that dollar index.
Earlier this year EU authorities came together and decided they would pool their financial resources, particularly in the bond market, to try and allay some of the nasty effects of the coronavirus crisis on the economy. That is a game changer for the region's debt markets. And over the long-term, it really bakes in the euro's status as a global reserve currency. So over the long-term, that's a big support for the currency and it's already rallied pretty hard.
But it's not just the euro. So even sterling, which is a few months away from dropping out of EU trade structures without a safety net, has wiped out all of its losses for the year against the dollar and pushed markedly higher. So people are fishing around to explain what's been going on.
One thing that goes a long way to explaining at least some of it is the role of speculative accounts like hedge funds. Some of the other major markets are not particularly happy hunting grounds for them right now. So if you look at the government bond market, they're already juiced out. Prices are sky-high thanks to what central banks have been doing to try and support the global economy and it's kind of difficult to see where large further gains can come there.
Similarly, if you have a look at the equity markets, US equity markets are at record highs, believe it or not, given what happened in March, and it's a little bit brave to assume that there are large gains to be had quickly from these levels. Hedge funds are running a net bet against the dollar in the US futures market for the first time in more than two years. People are talking about an infatuation with dollar weakness.
So where does this lead? Well, it could spell a little bit of trouble for other central banks. Central banks, like for example, the European Central Bank, don't tend to like to see their currencies get too strong. It generally hampers their efforts to achieve healthy levels of inflation and it's also bad for exporters.
Now central banks came together and worked hard to cool down the dollar when it rocketed in March when the coronavirus crisis really bit into markets. Would they work together now to control what happens to the dollar in its decline? It's an interesting question and all eyes are on what ECB officials, in particular, will say from here. Either way, currencies look to be the place where volatility might live in markets for the next few months.