Investors holding foreign assets with exposure to the U.S. dollar have had a volatile ride year to date: up in Q1, down in Q2, and back up in Q3. Now that the dollar is near the year’s highs, can the rally continue? We believe it can in the near term, although our longer-term view is more nuanced. Here’s what we see ahead.
Multiple factors support dollar strength in the near term
Although the dollar is near its year-to-date high, it is likely to get support over the next year from relatively high U.S. interest rates—at least, compared with those of other major developed countries—expectations for tighter Federal Reserve policy, and the slowing in global growth.
The dollar is just below this year’s high
Source: Bloomberg. Shows U.S. Federal Reserve Trade-Weighted Nominal Dollar Index (USTWBGD Index),a measure of the value of the U.S. dollar relative to other global currencies. Daily data as of 8/27/2021. Past performance is no guarantee of future results.
1. U.S. interest rates are high relative to global rates.
So far during 2021, the dollar’s strength has been driven largely by the rise in U.S. interest rates relative to those in other major developed countries. Although U.S. yields are low in real terms—that is, adjusted for inflation—that hasn’t been enough to push the dollar lower. It appears that the market is viewing the recent inflation spike as transitory. Moreover, in the yield-starved world of government bonds, even the paltry yields on U.S. Treasuries look attractive.
U.S. yields are above other major developed-country yields