The dollar has become the world’s punching bag and it’s likely to stay that way for awhile.
The world’s reserve currency benefited in a big way from a flight-to-safety, which drove it to a three-and-a-half year high in March as the coronavirus pandemic spread to the U.S. Now, as the world’s focus has shifted back to fundamentals, the dollar has rapidly slumped to a two-year low.
Strategists say the dollar’s slide comes as the U.S. lags most of the world in halting the spread of the coronavirus, and some expect the U.S. economic recovery to lag others, including Europe. The dollar is also reacting to the prospect of mounting U.S. deficits and ultra-low U.S. interest rates well into the future.
“The move against the dollar is now broadening, not only more countries, like emerging markets currencies, but also more participants,” said Marc Chandler, chief market strategist at Bannockburn Global Forex. “Asset managers, speculators and the other big group, judging from the skew in the options markets, is the hedge funds, joining the dollar bearish party.”
Since the beginning of the month, the dollar has lost 4.9% against the euro, following a bet that the European Union economy will outperform the U.S. economy. The greenback, in the same period, has fallen 2.5% against the yen; 6.4% versus the Swedish krona and 4% to the New Zealand dollar. In emerging markets, the Brazilian real has risen more than 6%, and the Mexican peso is up 4.9 % against the dollar. China’s currency, controlled by its central bank, is up just about 1% against the dollar in July.
The dollar index, which measures the U.S. currency against a basket of currencies, is down 3.77% in July, its worst monthly loss so far since April, 2011, when it lost 3.85%.
“In a way, it’s a perfect storm. We have all these things lining up,” said Jens Nordvig, CEO of Exante. “The dollar was strong for six years, and it’s only now that it’s starting to correct.” He expects the euro to reach 1.20 to the dollar in the near-term and then head back toward 1.30-1.35 per dollar.
The massive U.S. deficit, at a trillion dollars to start the year, has swollen into multi-trillions as the U.S. spends to fight the coronavirus. The dollar could respond to that well into the future, as the U.S. issues more and more debt, and the Fed buys Treasurys and other assets, while holding its benchmark federal funds rate at zero.
“We have some kind of global recovery going on and some countries are doing better than others. The U.S. is among those doing the worst (with the virus), along with Brazil,” said Nordvig. He said the failure to control the virus means more businesses cannot operate normally, resulting in more potential failures and a more sluggish economy.
“The U.S. fiscal deficits and the need for monetizing that deficit is far bigger than any other country in the world,” he said. The federal budget deficit was estimated to be a record $2.7 trillion for the first nine months of fiscal year 2020, according to CBO estimates.
Nordvig said the market is also sniffing out the potential for inflation, with all the global stimulus aimed at the crisis. “The price action you’re having is reflecting the concern that maybe the tipping point is close,” he said.
He said the dollar move is a bigger trend that should continue, and the momentum could feed on itself. “It’s hard to say when it could stop,” he said. “I think G10 currencies are the ones that move the most in a scenario like this.”
The dollar’s pain has been gold’s gain. The precious metal surged to a new all-time high of $1,941.90 per ounce in the futures market Monday, and is up 7.2% so far in July. Gold futures for August settled up 1.8% Monday, at a closing record of $1,931.50 per ounce. The gold rally has also been fueled by central bank stimulus, fears of inflation and the falling dollar.
Gold has been moving higher with stocks, with the S&P 500 up 4.2% for July. The stocks of multinationals benefit from a weaker dollar because it makes the cost of U.S. goods and services cheaper in foreign currencies.
“For me, the dollar, gold and the stock market are all parts of the same story,” said Chandler. “Gold, the stock market and the dollar decline is correlated to the decline in U.S. interest rates.” The 10-year Treasury yield has been trading under 0.60%, and on Monday, the Treasury’s sold 5-year notes Monday, at a record auction low yield of 0.288%.
The real yield of the 10-year, when considering inflation, would be negative. “The U.S. is losing its interest0rate advantage. That leg is being knocked out from under it. The negative rates support the idea of gold, and tell people there’s a little to do with their money besides buy stocks,” said Chandler.
Chandler said the foreign exchange market is not yet trading on the presidential election, but concerns of a Democratic win could be a negative for the dollar because of fears of higher taxes.
“This adds to the dollar’s bearish sentiment, but it’s still on the margin. It adds fuel to the fire, but it’s not the fire yet,” Chandler said.
Nordvig said the stock market can continue to rise as the dollar declines, unless it moves very quickly. If investors were to head to overseas equity in a big way, that could hurt U.S. stocks.
“If the dollar leaks lower that’s one thing, but if it’s an exodus, it takes things down,” he said. Nordvig said investors began to move more into international stocks in May and continue to do so.
–-CNBC’s Gina Francolla contributed to this story