Why the US dollar will remain on the comeback trail for many months
- While the dollar outlook has been cloudy in the recent years, it is fighting back, thanks to tougher interest rate tightening expected from the Fed and a brighter political climate under US President Joe Biden
It’s no surprise the US dollar index against a basket of major currencies recently hit a three-month high. The dollar should remain on the comeback trail for many more months to come.
It’s already boosting recovery expectations and reviving the US job market, generally perceived as a lagging indicator of economic well-being. US employment payrolls rose 850,000 in June, beating the 700,000 forecast, with the unemployment rate unexpectedly rising to 5.9 per cent from 5.8 per cent, a positive sign though, considering that more people were seeking work and now being counted among the jobless.
It’s no surprise that recovery expectations are riding high with the US growth rate expected to reach 6.9 per cent this year, according to forecasts from the Organisation for Economic Cooperation and Development. This compares more favourably than the 2021 growth forecasts of 4.3 per cent for the euro zone and 2.6 per cent for Japan, although China is expected to come through stronger at 8.5 per cent growth.
It’s why global investors remain so upbeat about the outlook for US equity markets this year as the US economy returns to better health. US growth momentum is expected to carry through to an above average 3.6 per cent expansion rate in 2022. Overseas demand for the US equity rally should exert major pulling power in the dollar’s favour this year.
The odds of a Fed rate hike this year are rising but it may take a few years before US interest rates return to more normal levels in a 2-to-4 per cent range. At the moment US interest rate futures markets still seem cautious and looking for no more than 1 per cent of Fed tightening over the next year but this could quickly change.
Expectations about the speed of future rate moves will be the key to understanding the impact on currency perceptions. The European Central Bank and the Bank of Japan will find it less easy to tighten in the face of economic uncertainties and weaker recovery prospects, so it will be up to the Fed to lead the charge when the move towards higher interest rates finally gets into gear.
Europe and Japan will be happy to let the Fed take the initiative and enjoy some competitive edge for their exports as the dollar strengthens.
Domestic-led strength may be the primary goal in the future but Beijing will want to tap into any vestige of export-led recovery to keep underlying gross domestic product growth above 6 per cent in the interim.
Keeping the renminbi trading above 6.50 yuan versus the dollar would definitely help maintain China’s competitive edge.
David Brown is the chief executive of New View Economics