Why ‘King dollar’ is reigning supreme

Abstract

▀ After a pause in late 2017 and early 2018, the dollar has resumed its rise. Our analysis suggests the long‐term factors influencing the dollar are likely to remain supportive in 2020, ebbing only in 2021. ▀ Alongside positive interest rate differentials, several key factors explain the recent dollar strength including relatively strong economic growth, a contained external deficit and significant equity market outperformance. ▀ Over 2018–2019 US growth has been faster than the rest of the G7, which suffered more downside surprises this year. Meanwhile, the deterioration in the US external deficit was less than expected, despite the Trump fiscal stimulus. ▀ The massive improvement in the US oil balance over recent years looks like an important long‐term structural support for the dollar. It allows the US to grow faster and have a stronger currency than would otherwise have been the case. ▀ The dollar is also supported by its still‐dominant position in global financial markets. Recent talk of ‘de‐dollarisation’ looks to be largely hype ‐ the dollar's share of cross‐border transactions, trade invoicing, and FX reserves is high and either stable or rising. ▀ The conditions necessary to create another dollar bear market like that in 2002–2008 may be hard to reproduce. A period of relative underperformance in US stocks is conceivable, but the 2002–2008 period also featured large US basic balance of payments deficits and persistently negative long‐term real yield differentials, which look less likely to materialise.