U.S. Dollar Outlook: What Could a Weaker Dollar Mean for Your Portfolio?
The U.S. dollar has fallen by about 7% against a broad basket of currencies since its mid-March peak. After a nearly decade-long bull market that saw it appreciate by more than 40%, we believe the dollar could be headed for a longer-term decline. Because the dollar is the world’s reserve currency, a change in its direction should be positive for growth in the global economy and for globally diversified portfolios.
The value of the U.S. dollar has been climbing for nearly a decade
Source: Bloomberg. U.S. Federal Reserve Trade Weighted Nominal Broad Dollar Index (USTWBGD Index), a weighted average of the foreign exchange value of the U.S. dollar against the currencies of a broad group of major U.S. trading partners. Daily data as of 7/27/2020. Past performance is no guarantee of future results.
The case for a lower dollar
Four factors that typically influence the dollar’s direction have shifted from bullish to bearish since the onset of the coronavirus crisis.
1. The Federal Reserve has shifted to a zero-rate policy.
The Federal Reserve’s response to the drop in economic growth resulting from the COVID-19 crisis has significantly narrowed the gap between U.S. interest rates and those in other major countries. Before the Fed pivoted to a zero-interest-rate policy in March, U.S. short-term yields were 213 basis points and 173 basis points higher than policy rates in Europe and Japan, respectively.1 While U.S. rates are still higher today, the gap has narrowed substantially: The federal funds rate is just 63 basis points higher than Europe’s policy rate and 23 basis points above Japan’s.
More importantly, real U.S. interest rates (adjusted for inflation) are now negative. All else being equal, higher interest rates make a currency more attractive to hold, and vice versa. More recently, growth prospects have slowed while inflation expectations have risen, which has sent real interest rates down in the United States—another factor making the dollar less attractive to hold.
Real yields have fallen during the past few months
Source: Bloomberg. Shows real yields for 10-year bonds and two-year notes using the core Consumer Price Index (which excludes food and energy prices) as the measure of inflation. Data as of 7/27/2020. Past performance is no guarantee of future results.