The Sum of All Fears Is Falling With the Dollar

Dollar Dolor

It’s been a spectacular year for the US dollar. Using the popular broad dollar index, it managed to rise to its highest level since 2002 by the end of September. Since then, the greenback has endured a peak-to-trough fall of more than 9% and continues to trend downward. A look at the chart suggests that another great dollar rally is over. The question remains: Has Wall Street really seen the dollar’s top?

To many, the answer is likely yes. That the dollar had a record run can be attributed to three main factors: China’s (then) aggressive Covid-Zero policy, Europe’s confounding energy crisis, and the Federal Reserve’s determination to curb sky-high inflation. Between them, the presence of so many risks convinced investors around the globe to take shelter in the traditional haven of the dollar. Here’s George Saravelos, global head of foreign-exchange research at Deutsche Bank AG:

Those three risks marked a definitive peak in November, in turn allowing for a sizeable USD turn. The dollar’s previously huge risk premium now looks far less stretched, also accompanied by a shift in speculative positioning to neutral.

The graph below shows the dollar risk premium, which is Deutsche’s measure of how well a currency is performing compared to what would be expected from standard monetary drivers, such as differential in interest rates. After a couple of dramatic switchbacks since the beginning of the pandemic, it’s looking more and more normal. This year’s peak surpassed 2020’s Covid high, but it’s been downhill since. The next question is will the dollar continue to fall? The answer: probably not.