The US dollar is likely to remain weak – Charles Schwab

Economists at Charles Charles Schwab think that the dollar is in for a prolonged decline for the following reasons: the Federal Reserve has shifted to a zero-rate policy, US growth is likely will underperform other major economies due to the coronavirus, political uncertainty has risen and increasing US budget deficits will need to be financed with foreign capital.

Key quotes

“The Fed’s policymaking arm, the Federal Open Market Committee, has indicated it will hold interest rates near zero for the foreseeable future, with Fed Chair Jerome Powell reinforcing that sentiment when he said members were ‘not even thinking about thinking about raising interest rates.’ Combined with concerns that the US will trail other major economies coming out of the COVID-19 crisis, this has caused the 10-year Treasury yield to decline and converge with other major developed-country interest rates, which makes the US dollar less attractive to foreign investors searching for yield.” 

“It’s actually the spread of international real interest rates (yields adjusted for inflation) that is a significant factor affecting currency fluctuations. And while nominal interest rates, such as the 10-year Treasury yield, have fallen to record lows, real interest rates have fallen even further into negative territory. One reason for this is an increase in inflation expectations, fueled by the Fed’s intention to let consumer prices overshoot its 2% longer-term target, massive monetary stimulus, and the risk of a feedback cycle of a weaker dollar (which can result in higher import prices).”

“Fiscal stimulus spending is resulting in growing US budget deficits that will need foreign financing to fill. With interest rates held down by the Fed and weak growth expectations, a lower dollar will likely be required to entice international investors to buy.”

“While the dollar is likely to remain the primary reserve currency, heightened political uncertainty in the US could make other countries look relatively stable, barring a renewed crisis.”

“We expect the US dollar to decline over the intermediate-term – but investor sentiment on the dollar has become much too dour, in our view, which raises the possibility of a short-term bounce.”