Investors are pining for a top in the U.S. dollar, with some predicating calls for near-term stock market gains partly on expectations for a weaker U.S. currency. Dollar bulls say, don’t count on it.
“Our view remains that the dollar is more likely to strengthen further than to fall,” said Jonas Goltermann, senior markets economist at Capital Economics, in a Wednesday note.
The ICE U.S. Dollar Index DXY, +0.06%, a measure of the currency against a basket of six major rivals, is up 1.1% so far in November, taking back a little more than half the ground it lost in October. The index’s October pullback from a more-than-two-year high, however, encouraged investors who had been looking for a turn away from dollar strength to provide a positive backdrop for equities, particularly cyclical stocks.
A weaker dollar can be a plus for export-oriented multinationals and commodity producer, making their products cheaper relative to foreign buyers.
Stocks, meanwhile, have continued to rally in November, pushing further into record territory, with the S&P 500 SPX, -0.11% up 1.9% so far this month, contributing to a year-to-date gain of more than 23%. The Dow Jones Industrial DJIA, +0.07% is up 2.6% this month for a 19% 2019 rise.
As for dollar bearishness, Goltermann noted the most recent Bank of America Merrill Lynch survey found global fund managers were more bearish on the dollar than at any time since 2007, while a Bloomberg survey found forecasters looking for the U.S. unit to lose ground against both the EURUSD, -0.0272% and the British pound GBPUSD, -0.0234% next year and in 2021.
Upbeat expectations around a potential “phase one” U.S.-China trade deal, and easing worries over global economic growth and the potential for a recession, have seen the U.S. dollar lose some of its haven appeal. But Goltermann contends that those factors are unlikely to have legs.
“Even if a limited [U.S.-China trade] deal is agreed, the underlying issues are unlikely to be resolved and tensions are likely to remain high. We also expect that the global economy will slow further over the next couple of quarters and won’t rebound strongly thereafter,” Goltermann said.
And then there’s that crucial currency driver — relative interest rates. While no big shifts in rate differentials between major economies are likely in the cards, any moves are still likely to favor the dollar, Goltermann said, with both the European Central Bank and the People’s Bank of China on track to further loosen policy in 2020, while the U.S. Federal Reserve appears near the end of its easing cycle.
Indeed, Fed Chairman Jerome Powell, in testimony before Congress on Wednesday, reiterated that it would take a “material” change in the outlook for the central bank to make a policy move. In other words, after delivering three rate cuts in 2019, it’s in no hurry to ease further unless economic conditions deteriorate.
Moreover, Goltermann argued that the dollar, while rivaling the strength it saw in the early 2000s, just isn’t “obviously overvalued” the way it was in the mid-1980s. At the time, the real dollar exchange rate against other advanced economy currencies was about 15% stronger than now, he said, which means that the dollar’s present valuation likely won’t prevent it from rising “a bit further” over the next couple of years.