Why US dollar bears should watch out for November’s presidential election

The dollar is being undermined by loose US monetary policy and uncertainty surrounding the outcome of the poll. The latter could mark a turning point for the currency
While Trump should manage the dollar in a globally responsible manner, Beijing has plenty of scope to target a weaker renminbi while inflation risks remain low

David Brown

Published: 10:00pm, 7 Sep 2020

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There’s a saying in financial markets that it’s never a good idea to stand in the way of a speeding express train – even if it is running in reverse. The falling US dollar is building momentum and it could soon be testing central banks’ patience if it poses any threat to global recovery. Dollar bears must be wary as the central banks generally tend to get what they want. The runaway train could hit the buffers sooner than expected if dollar intervention is looming.

The market believes the dollar is being undermined by over-loose US monetary policy and, with a potentially messy US presidential election battle looming in November, investors are understandably keeping a safe distance. There’s a limit to how far the negativity might run, as most central banks are committing similar monetary debasement to their currencies, and US political risks should dissolve quite quickly once the US elections are over.

In currency markets, there’s no such thing as a safe one-way bet, and the dollar could well surprise on the upside once sentiment recovers.

Intervention risks are rising with Europe and China worried about obstacles to recovery as their currencies get stronger and their export competitiveness continues to suffer. European Central Bank officials are already voicing concerns about the strong euro, with the currency recently touching a two-year high of US$1.20.

With the euro already stronger this year to the tune of 10.8 per cent against the dollar from its weakest point, it means much tighter trading conditions for European firms in world export markets. The stronger euro is not only hurting exporters, but it has also pushed euro zone inflation back into negative territory for the first time since May 2016. This builds pressure on the ECB either to come up with more monetary easing or else intervene heavily in the forex markets.

An employee walks beside racks holding doors for all-electric Porsche Taycan luxury automobiles at the Porsche factory in Stuttgart, Germany, on March 5. A stronger euro is hurting exporters. Photo: Bloomberg

China must be prepared to be more proactive with currency intervention as dollar vulnerability could easily turn into a rout. So far the renminbi’s gains versus the dollar this year have been relatively modest, rising 4.6 per cent from its weakest point. But it is still a setback with Beijing trying to garner as much recovery potential for the economy as possible.

With China’s export performance showing more signs of life recently, a sharply weaker dollar would be a major blow to Beijing’s hopes for faster export-led recovery while the domestic economy catches up.

US President Donald Trump seems happy to use a weaker dollar as an extra bargaining chip to force China and Europe round the negotiating table to settle trade differences. But it’s a dangerous game which could easily backfire, upsetting global recovery and financial stability if it leads to a full-scale currency war.

US benign neglect towards the dollar is not an option while trade tensions remain so acute with China and Europe. The Fed is simply following its instincts easing monetary policy to boost the US economy, but it’s up to Trump to manage the dollar in a more globally responsible fashion and to help calm markets in the process.

Beijing has plenty of options to fall back on, not least lower interest rates, easier credit conditions and more fiscal reflation to jump-start domestic recovery. China’s economy may be turning the corner towards stronger growth but still needs more support from the export sector to consolidate the process. Beijing has plenty of scope to target a weaker renminbi while inflation risks remain so low.

Official intervention will be needed if a break through last year’s low of 6.6844 yuan against the dollar is on the cards. If that happens, dollar bears would quickly set their sights on the next major resistance point at 6.2650 yuan, marking the dollar’s 2018 low point.

Why China’s digital currency won’t threaten US dollar dominance

Beijing must be ready to react with much more aggressive intervention, buying dollars and US Treasury bonds should market conditions begin to deteriorate ahead of US elections on November 3.

The elections should mark a turning point for dollar perceptions. If all goes well, political risks should eventually settle down and the dollar should begin to find some notional short-covering support. Investors should be able to weigh up the US’ prospects on the strength of relative recovery fundamentals.

A US economy in better health should be dollar positive in the long run, especially if the Fed draws a line at negative interest rates.

David Brown is the chief executive of New View Economics

This article appeared in the South China Morning Post print edition as: Bears beware: weakness in US dollar cannot go on forever

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