If you follow the thinking in the media, it would seem that the strength of the USD is a fact of life. I am not convinced that this trend will continue for very long. Since the USD crossed 1.0860 EUR/USD (lower band level 2023/2024), the euro has fallen very quickly. We are now just below 1.03 EUR/USD and I suspect that, given all that the new Trump administration will unleash, it is conceivable that the euro will approach the October 2022 high (0.96 EUR/USD) in the first half of 2025.
Higher Interest Rates are no Explanation for USD Strength
The USD is not only strong against the euro, but also against sterling, the Swiss franc, the Australian dollar and virtually all Asian currencies with similar rates of appreciation to the euro.
Interest rate differentials are not a convincing argument for currency movements. Both the pound and the Australian dollar have interest rates higher than or equal to the USD and are losing ground against the USD as much as the euro.
On average, the Swiss franc has a lower interest rate than any other currency and is the strongest currency in the world, having tripled in value against the US dollar over the past 40 years, despite the fact that the US dollar pays a good 2.5% p.a. more in interest than the Swiss franc.
Higher Productivity is Not a Reason for the USD Dominance
Thirty years ago, the internet boom led to media hype about how it would make the US economy so much more productive.
These productivity gains were not wiped out overnight in 2000. Nonetheless, the USD began an epic slide in the autumn of 2000, weakening only moderately with sharp swings until 2002, but then depreciating by 50% in 2008.
The Trade Deficit is Not a Reason for the USD Weakness – for a Longer Period of Time
The US has long had a tendency to run trade deficits, which have proved to be a drag in the long run, but have been ignored for a surprisingly long time. Trade deficits tend to spike when commodity prices rise sharply. This happened in 2004-2008 and 2020-2022, with varying consequences.
In the noughties, the USD depreciated sharply as the trade deficit widened. In 2020-2022, the USD initially depreciated moderately, but the outbreak of war in Ukraine led to a significant appreciation of the USD against the euro (and most other currencies).
I think the momentum of the widening trade deficit in the noughties was much stronger than in recent years, and that weighed on the USD. Over the past five years, the trade deficit has continued to widen, but the momentum and direction of the trend have not been as strong as in the noughties. In addition, the main driver of exchange rates has had a strong counteracting effect.
In the Past and Today, the USD Has Shown Strength When Stock Markets Have Risen
In this issue, I will focus on a fundamentally simple and straightforward observation, outline the current environment, and ‘challenge’ my conclusions.
Conditions today are very similar to those 25 years ago. With one big and important difference: the US was at the height of its power. China was insignificant and Russia was still reeling from the 1998 Russian crisis and internal power struggles. Today, the US is being challenged, which does not change the economic facts but increases the risk and volatility potential in the markets.
