Dollar Is Poised to Weaken Just in Time
(Bloomberg Opinion) -- The days of a strong dollar look as if they're coming to an end -- and not a moment too soon.
If the dollar does weaken, we may finally see the kind of durable and robust growth that the U.S. has only had in fits and starts since the financial crisis ended.
Let's tick off a few of the events that should figure in a weakening dollar: The Federal Reserve has given indications that it will wait for a truly hot labor market before raising rates; the resounding election victory of conservatives in the U.K. gives clarity on Brexit, leading to a stronger pound; and the U.S. and China may be getting closer to putting together terms for a trade deal.
The dollar's surge began in July 2014, seven months after the Fed started winding down the quantitative easing program it used to battle the Great Recession. That shift changed the focus of market participants to when the Fed would begin increasing the fed funds rate from roughly zero, where it had sat since the financial crisis. At its June 2014 meeting, the Fed's dot plot showed that members of the Federal Open Market Committee projected that the central bank would raise interest rates three or four times in 2015.
Anticipation of tighter monetary policy when the rest of the world's economies were still weak, with their central banks holding interest rates near zero and steady, led to a 25% rally in the dollar in the next 18 months. Coinciding with that rise was a collapse in the price of commodities such as oil, economic turmoil in emerging markets and a slump in global manufacturing.
This foiled the plans of Fed policy makers who believed they saw signs of full employment and inflation as early as 2014. Due, in part, to the strength of the dollar and weakness in commodities and commodity-related industries, the Fed's preferred measure of inflation grew 1.7% year-over-year in July 2014. But by December 2015 it had declined to only 1.1% year-over-year, well below the central bank’s inflation target of 2%.
The global recovery that began in early 2016 started to reverse the dollar's gains. But the approval in the U.K. of the referendum to leave the European Union that June led to a significant decline the British pound, creating fresh demand for the dollar as a safe haven. Meanwhile, starting in 2015 and continuing through late 2018, the Fed raised interest rates from a little more than zero to 2.5%, making U.S. assets more desirable and increasing demand for dollars to invest in them. And then in 2017 President Donald Trump embarked on a trade war with China, leading to a new round of dollar strengthening and slowing inflation.
If the dynamics buoying the dollar during the past five years have been overly hawkish monetary policy, Brexit uncertainty and the repercussions of the trade war, then it now look as if we're in a new environment where the dollar may finally move lower.
And that could be the impetus that pushes the global economy into higher gear in 2020. Large moves in the dollar have multiplying effects. A strong dollar tends to push down commodity prices, weaken growth in emerging markets, create disinflation in the U.S. and make American workers and industries less competitive in the global market. A weak dollar does the opposite. A rebound in commodity prices could contribute to a new cycle of global investment. Higher import prices should put upward pressure on domestic prices, helping the Fed hit its 2% inflation target. A weaker dollar also would make U.S. products more competitive on world markets and lift wage growth closer to 4%, a level it reached during the last two economic expansions but not in this one.
Most of the economic expansion during the past decade has been accompanied by one or more drags on growth, whether it was corporations and consumers paying down debt and government austerity early on, or the trade wars more recently. But now more pieces are falling into place for the dollar to weaken amid Fed willingness to let the economy run hot for a change, more certainty that Brexit will come about and the lowering of trade tensions. Amid that backdrop, the U.S. is in a good position to return to a more consistent growth environment.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Conor Sen is a Bloomberg Opinion columnist. He is a portfolio manager for New River Investments in Atlanta and has been a contributor to the Atlantic and Business Insider.
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