Post-pandemic: The USD and a deglobalised world
Global coronavirus cases are close to topping 14 million and transmission remains exponential. The world’s largest economy, the USA, is posting more than 60,000 cases per day. As resistant as many countries have been to lockdowns, the prospect is now real in the USA and some economies that had reopened, such as Beijing and Melbourne, have gone back into lockdown due to second waves. As the virus fears linger, an employment and consumer rebound is pushed further into the future.
International travel will remain subdued for some time, possibly until both a vaccine is readily available and the curve starts to flatten globally. Meanwhile virus shutdowns have choked global supply chains. Our new normal is a less globalised world, and this is something that could weigh on the US dollar. Let me explain.
Deglobalisation and slowbalisation - our less connected world
Global trade has been sluggish for years, and the pandemic will hinder it further. Global trade accelerated ahead of the GFC but slowed since. A recent wave of protectionist politics across the world (see Brexit and the rise of the Trump administration) confirmed the sluggish trend was here to stay. See the chart below, where you can see the slowing rate of global exports as a percentage of global GDP, after an accelerating trend into 2008.
Global trade has stagnated since the GFC. Chart source data: The World Bank
Our post-pandemic world will probably exaggerate that sluggish trend since 2008. Global supply chains were choked during lockdowns, hindering the movement of goods particularly out of China. This highlighted a reliance on global trade, something which will inspire many countries to be more self-reliant on the other side of this.
We’re also seeing geopolitical ties fracture further. US-China relations are the worst they’ve ever been. The Trump administration has blamed Beijing for the pandemic, saying the relationship has been “severely damaged”, leaving little hope for a phase two trade deal.
It’s not only the USA though, tensions are also bubbling between Australia and China, especially after Canberra endorsed an investigation into China’s handling of the virus. Beijing slapped steep tariffs on Australian barley and warned its students against studying its universities.
Over in Europe, the European Union has been divided over fiscal relief for member nations devastated by the virus. The fiscally conservative faction have so far resisted a shared debt burden, but progress is soon expected on the EU’s €750bn recovery fund. President of France Macron warned the EU faces collapse without a joint recovery, so progress here should boost the euro. It’s all a reminder of the shared currency’s shortcomings.
Deglobalisation: bullish or bearish for the US dollar?
The US dollar has ended its multi-year bull market. As the crisis cools and global markets eventually rebound, the US dollar could enter a multi-year bear market. Low policy rates will exaggerate the selling pressure.
The US is the world’s largest economy and one of the most self-reliant major economies. The Trump administration has ramped up protectionist policy, and if Trump were to win this year’s election, the trend will continue."
Sure, the US has a relatively closed economy so is more resilient in tough times. This is why the USD and US equities outperformed in recent years as global growth slowed, but that trend might be on the verge of reversal as the growth gap shrinks for two main reasons.
One: The US will lag the rest of the world in the COVID recovery. As the rest of the world (RoW), especially Europe, recovers earlier, the growth gap will shrink and capital will flow out of the US and into RoW assets. As this happens, there’ll be less demand for the US dollar and more demand for RoW currencies and assets.
Two: As the rest of the world recovers, the US will be less exposed to the rebound in global trade due to its relatively more closed economy. Again, a negative for the US dollar.
Not to mention the monetary background is also USD-negative. The greenback had an interest rate appeal for carry trades, and lost that appeal when rates were slashed to zero. Low interest rates also push investors out of cash and into growth assets, hence the never-ending highs on the tech index NAS100, as well as investors hedging uncertainty with safe havens like gold. This all puts downward pressure on the world’s reserve"currency.
The US dollar index
I like to think about the USD in terms of the US dollar index (USDX), which measures the greenback against a basket of six currencies. The euro has an almost 60% weighting in the basket, so moves here are most heavily felt in the EURUSD cross with a move in the opposite direction.
In the short-term, I’m watching the 96.00 handle for indication of an immediate move lower. At this point, we’re probably looking at a EURUSD valuation above 1.14, which was the case when the USDX closed below the 96 handle on Wednesday. A close below wasn’t enough quite yet to drag the USD broadly lower though, with buyers coming into the market and lifting the greenback at what must have felt like a bargain"price.
So I’m not only watching for a close below the 96 handle to understand where pairs like EURUSD, GBPUSD, and USDJPY might be headed, but I’m also watching the market reaction to see if buyers emerge and keep the USD buoyant. The USD has so far found buyers below the 96 handle both in early June and mid-July.
If we look at history, easy policy after the GFC pushed the US dollar index (USDX) into a bear trend. This time, rates are near-zero not just in the US but in many other major economies too, which means a larger pool of investors seeking growth assets - something that can be a USD-negative. But looking at the USDX chart, if the 94.50 - 96.00 range is seen as cheap, it would be a sign to me the selling pressure isn’t strong enough to start a bear trend, just yet at least.
US election a USD-negative too
US election risk is just around the corner. The bullish case for equities would be a red-sweep, as the Trump administration has been extremely pro-business. Yet as public opinion of President Trump falls largely due to his pandemic response, a second term looks less and less"likely.
Markets will be cautious of a Biden administration, which promises to hike the corporate tax rate and influence a financial transactions tax - although this comes alongside a €2tn fiscal spend to support a struggling domestic economy. Whether or not the senate flips blue is another big question for markets, as it will determine the ability of democrats to pass new legislation.
History shows us that USDJPY is the favoured election hedge, with the JPY strengthening on safe haven flows. US election risk is another negative for the USD.
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