USD weakness is not surprising – Morgan Stanley

The US dollar may finally be losing its luster. The US Dollar Index peaked on March 20th, but has since fallen 8% through July 24th. Lisa Shalett from Morgan Stanley sums up three recent catalysts that have contributed to a weaker dollar. If USD weakness persists, it could push up US inflation and press down on equities.

Key quotes

“Europe and the UK are on the upswing, and so are their currencies. The US’s biggest trading partners are both benefiting from massive fiscal stimulus and relative stability in terms of their coronavirus infection trajectories. I’m particularly encouraged that the EU passed its first joint stimulus plan in July, finally crossing the threshold for the kind of fiscal integration that could lift economic growth in the region and boost the common currency. A related point: With yields on US government debt now close to the level of other developed nations, the global appetite for investing in Treasuries may wane, which would also pressure the dollar.”

“US money supply has grown rapidly. Fed monetary easing and US fiscal expansion have been unprecedented, following the sudden-stop economic contraction brought about by the pandemic. Rapid expansion of debt and deficits serves to debase the dollar in the long run and may lead to inflation.”

“Trade and geopolitical dynamics are shifting. After five years of improvement, the US current account deficit is growing and could approach 4% of GDP by next year. At the same time, geopolitical tensions are rising and US global leadership has waned, while China’s economic standing continues to rise. This dynamic may lead central banks to restructure their monetary reserves, selling some dollars and potentially buying renminbi. That could also contribute to a weaker dollar.”