Is it a Flash in the Pan or the End of a Long Upward Trend?
In recent years, I have never tired of highlighting the weakness of the euro against the US dollar, bearing in mind that the US dollar’s strength was not confined to the euro, but was also evident against major currencies and Asian currencies. Emerging markets also tended to weaken against the USD, of course.
The Era of Outsized USD Strength is Over
As always, the end of a long-lasting trend is hard to believe. However, looking at developments over the last six months, it is clear that the USD strength that has persisted since the financial crisis of 2008/2009 has come to an end. A key factor in the USD’s strength was the acquisition of unhedged securities positions in the US market. Investors benefited twice: from the market’s good performance and from the strong USD.
The stock market recovery from 9 April to the present day shows that the indices have fully recovered, but the USD continues to trend downward after a brief flare-up at the start of the year.
Unreserved Confidence in the USD is a Thing of the Past
This trend makes this statement clear. When foreigners buy US equities or bonds, they tend to do so in conjunction with a currency hedge. However, I would assume that foreign investment in both bonds and equities is not as substantial as that of US investors.
Stabilisation is a Temporary Phenomenon
Despite the current optimism, it must be made clear that it is built on sand. The trade discussions with China and the EU are far from settled.
The USA also wants to prevent other countries from imposing rules on US companies that would put them at a disadvantage. This will make trade agreements even more challenging to negotiate. For the US, ‘unhindered access’ for digital giants to the European market is important because these companies are not welcome in China anyway. US companies around the world are increasingly competing with Chinese providers who, for the most part, offer no recognisable added value.
Asian Countries Increasingly See the USA as a Burden
I would not be at all surprised if the crude and unreliable approach of the Trump 2.0 administration were to be perceived as repugnant and unjust in Asia. Trump acknowledges with approval that Asia is focusing more on itself and is being driven ever closer to China, which is already the most important trading partner for most Asian countries.
If I Were China, I Would Open Up the Capital Market
The USA is far more vulnerable than we realise. Its dependence on the inflow of foreign capital is the main reason for its weakness. This mainly comes from trading partners who have achieved surpluses with the US and now hold vast fortunes in the country. Foreigners currently own around 25% of the US stock market and nearly a third of US bonds. The problem with the USA is that it was too easy to incur debt at low interest rates, and that debt was foolishly run with very short maturities. This is now resulting in higher interest rates. Interest payments are now flowing abroad at a time when there is less and less appetite to purchase more bonds at comparatively low interest rates given the increasing risk. The prospect of being forced to buy will not be well received.
If China were to respond to this unwelcome US policy by opening up its capital markets, demand for US assets would likely decrease significantly. This would also cause the USD to weaken, with dramatic consequences for the Western financial system.
