After months of weakness and growing calls for a dollar bear cycle, the world’s reserve currency has managed to catch a bid this month. Although further dollar downside is expected, we may not see much more this year.
What’s Driving the Dollar Strength?
As is the case so often with the markets, there is no one clear driver behind the move. If we look across all asset classes, we can see that the risk mood has softened this month. In the past couple of weeks, concerns about the economic recovery have begun setting in. We also have the US elections coming up in November, and as mentioned in an earlier post this week, a tight election could lead to prolonged political uncertainty.
Furthermore, the passing of Supreme Court justice, Ruth Bader Ginsburg, has diminished hopes of a new fiscal stimulus package before the elections. This week, we have seen multiple Fed members, including Jay Powell, pushing for fiscal stimulus. The Federal Reserve prefer to distance themselves from politics, but the push for further stimulus from Fed members indicates the necessity for fiscal aid.
Fiscal Aid – Yes…but No?
For around two months, the Democrats and Republicans in Congress have been deadlocked in negotiations over a new fiscal stimulus package. Both parties agree that further aid is needed to support the economy, but they have failed to agree on the size of the package. There is also the issue of how the money should be used.
Although talks have continued this month, a deal has not looked achievable.
Expectations took a further hit following the passing of Ginsburg. Tensions have escalated between the Republicans and Democrats as Trump looks set to name a nominee to the Supreme Court bench this week. Since we are just weeks away from the elections, the Democrats argue that any nomination should be made after the elections. Any hopes of a last-minute breakthrough in talks look to have been dashed. Further stimulus is now unlikely until after the elections as Congress will be leaving Washington soon to prepare for the elections.
For the dollar, this means that the supply of the currency in the markets will not increase as much as expected. A new stimulus package would have been funded through the issuance of more debt, and a large portion of that would have been bought by the Fed through quantitative easing. The fact that we are unlikely to get a stimulus package in the near-term is helping to push the dollar higher.
Concerns About the Economic Recovery
Several countries are now experiencing a second wave of the coronavirus, and this has elevated the need for fiscal stimulus. In particular, the rise in cases across Europe has seen the introduction of new restrictions. European governments are reluctant to impose nationwide lockdowns again because of the economic damage it would cause, but they are hoping that new restrictions will stem the spread.
The PMI figures from Europe this past week indicate that the eurozone services sector has fallen back into contraction territory this month. It was expected that the economic recovery would slow towards the end of the year, but now the markets are concerned about the recovery stalling. This is another driver of the recent risk off tone in the markets and has seen an inflow into the US dollar, which is seen as a safe-haven.
What’s Next for the Dollar?
As we move closer to the US elections, I am expecting the risk mood in the markets to remain fragile. This is likely to keep the dollar supported in the coming weeks. From a technical perspective, I have highlighted a multi-year trendline in the chart below. This was also posted on the fund’s twitter page a couple of weeks ago, and we can see clearly that support has been found here.
For the dollar bears to resume control, we would need to see a clear break below this trendline. Along with the elections, the economic recovery is going to play a key role here. If the recovery continues to show signs of faltering, then the dollar strength could continue into the end of the year. However, if a coronavirus vaccine were approved by the end of this year, we could see optimism creeping back into the market on expectations of the world getting back to normal by Q4-2021.