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Dollar decline: When the US coughs the world catches a cold

22 Sep 2020

How are record low dollar exchange rates affecting the rest of the global economy?

What a difference five months make. Back in April, as the effects of the Covid pandemic started to unravel across the globe, the value of the world’s reserve currency surged. Amid uncertainty across all major asset classes, the dollar was being perceived as a safe haven asset, much to the dismay of the US president and Wall Street.

Just a few months later, the greenback’s fortunes suddenly started to turn. At the time of writing, the broad dollar index has fallen for three consecutive months, a trend which is likely to have consequences for the global economy.

The fall in the value of the dollar has temporarily boosted the performance of US stock markets but could potentially turn into a headache for other developed markets, the eurozone in particular, which has seen the value of its currency rise against the dollar.

In contrast to the UK and US, the eurozone now has to grapple with falling price levels and the risk of deflation, a trend which could be at least partially driven by the change in exchange rates. Analysts are divided as to what drives the sudden change of fortunes for the dollar.

One major factor could be the US’ perceived handling of the Covid crisis, as the US struggles to get infection rates under control. When the US coughs the world catches a cold, as they say.

Another factor could be precisely the same that drove the dollar rate up earlier this year: Investors hunting for safe haven assets.

By the end of August, leveraged funds held more than 13,400 net short positions against the dollar, significantly outweighing long positions, according to the Commodities Futures Trading Commission.

But it is not just hedge funds that are betting against the dollar, asset managers and institutional investors also held a net short position against the greenback. With the US facing a further spike in Covid cases, race riots and a turbulent election period, short sellers seem to think that a bet against the dollar is a safe bet.

Conversely, for investors who do not wish to operate through short trades, the fall of the dollar has also had knock on effects on other safe haven assets, gilts in particular. Yields on 10-year bunds and gilts have fallen to a new low as the euro and sterling rose against the dollar.

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