Written by Mike Dolan
LONDON (Reuters) – The dollar had its best week in two years, showing once again how risky it is to bet against the greenback if the rest of the world doesn’t let it slide.
The DXY index, which measures the value of the dollar against the world’s most traded currencies, rose more than 2% last week – a stunning blow, especially for the many speculators who were selling the greenback and waiting for it to swoon.
While this rally was partly fueled by a stark US employment report – and the associated rethink of the Fed’s interest rate path – a dollar recovery was underway before Friday. The salary numbers are just the icing on the cake.
The main catalyst for renewed dollar strength has been clear signals coming from central banks in Europe and Japan that any efforts by the Fed to up the ante on interest rate cuts will be matched.
The rest of the world’s major central bankers have certainly taken note of the Fed’s massive opening push of 50 basis points last month in what it described as a 250 basis point easing cycle.
The move was followed by a series of pointed comments from the presidents and governors of the European Central Bank, the Bank of England and the Swiss National Bank. They all suggested that their decks be cleared for quick relief as well.
While the Bank of Japan was moving in the opposite direction, both the Bank of Japan and the new Prime Minister threw cold water on plans to continue “normalizing” policy with higher interest rates after the Fed’s big cut.
Add to this the signs that the SNB is already intervening in the currency markets to limit the rise of the Swiss franc, continued intervention from the Reserve Bank of India, and even the recovery of China’s foreign exchange reserves, and it is easy to see why the dollar will last for so long. – The expected downward path was thwarted.
An “amazing” accumulation of US assets
But truly large capital transfers strengthen the dollar less in the public sphere than in the private sphere, and reflect the seemingly insatiable appetite of foreign investors for US assets.
Kate Jukes, currency strategist at Société Générale (OTC:) puzzled this week about why the dollar was rising again so soon after the Fed started cutting interest rates. He noted that the dollar’s previous two multi-year rises over the past 50 years were completely reversed after the start of Fed easing.
Jukes highlighted data showing that Japanese trust funds have already resumed purchasing US Treasuries and that external demand for dollar call options is rising. A rapid return to already crowded US markets is, in his words, “taking US exceptionalism to new levels.”
So the dollar remains stubbornly overvalued: the broad, trade-weighted real index is still about 30% above levels seen ten years ago. This will create growing concern about the sheer size of global exposure to US assets, the strange shift in the dollar exchange rate and its impact on US competitiveness, and a re-emergence of the concern about “global imbalance” that was prevalent twenty years ago.
Juckes, the Société Générale strategist, stressed that foreign investors have increased their net holdings of US assets by a “staggering” $40 trillion since 2020 – making it remarkable that this thirst has not yet subsided.
“I’m sure a weaker dollar would help reduce some of the imbalances in the global economy, but if investors have such little confidence in their domestic politics and asset markets that they actually return to the US, how does that happen?” He said.
Moreover, there is no indication that US investors have a remote interest in the performance of weak foreign markets.
US mutual fund numbers have seen net outflows from global stocks over the past month, a fairly consistent trend since the Fed began raising interest rates in March 2022.
So what might shake investors’ long-held confidence in the resilience of the US economy, and thus the dollar?
Certainly, geopolitical concerns are as high as we have seen for many decades. But this arguably increases demand for safe-haven dollars, encouraging US money to hunker down at home and enhancing the appeal of unparalleled US size and liquidity.
Could the US election or threats to US democracy and institutions unnerve investors?
Donald Trump’s return to the presidency after the November 5 election could certainly raise concerns, especially in light of Trump’s apparent support for both a weak dollar and political control of the Federal Reserve.
But interestingly, even with the race for the White House on the brink, the world still seems determined to keep the dollar high.
The opinions expressed here are those of the author, a Reuters columnist