News Analysis
U.S. dollar has had a tremendous 2021, defying the market’s bearish expectations since the beginning of the year.
Over the last 18 months, the consensus on Wall Street has been that the dollar would endure significant weakness amid inflation worries, historically low interest rates, and investor confidence in a recovering global economy. Instead, the U.S. Dollar Index (DXY), which gauges the greenback against a basket of currencies, is up more than four percent year-to-date as traders continue to take cover from uncertainty by hiding in conventional safe-haven assets.
Since the end of the Second World War, the U.S. dollar has served as the premier international reserve currency, with foreign governments and central banks accumulating reserves of dollars instead of gold. Today, there remains a fierce appetite for Treasurys as foreign holdings of U.S. debt soared to a fresh record high of $7.56 trillion in August.
But there is a debate among experts as to whether this could be the beginning of a change in currency markets. America’s intensifying debts and deficits, the rise of other currencies, and the growing de-dollarization push have sparked scrutiny and discussion over the dollar’s long-term viability.
Bullish or Bearish on the Dollar?
According to the International Monetary Fund’s Currency Composition of Official Foreign Exchange Reserves (COFER) data, U.S. dollar reserves held by central banks declined to a 25-year-low of 59 percent in the second quarter of this year. Since the euro’s launch in 1999, the share of dollar assets in central bank reserves has fallen 12 percentage points, while the euro has gained approximately 20 percent. Australian dollar, the Canadian dollar, the Chinese Renminbi, the Japanese yen, and the Swiss franc have witnessed modest gains in allocated reserves.
Some market analysts purport that the dollar rally will be short-lived and that the greenback could weaken, mainly because of monetary policy. While the Bank of England and the Bank of Canada have already started tapering their asset purchases, the Federal Reserve has yet to definitively state when it is trimming its ultra-aggressive $120-billion-a-month quantitative easing program.
U.S. central bank has signaled it could begin winding down the stimulus and relief mechanism as early as the November Federal Open Market Committee (FOMC) policy meeting.
“ spike in the dollar has been noteworthy, but in our view, is likely to be temporary and we maintain our view for a softer U.S. dollar over the medium-to-long-term,” wrote Wells Fargo economists Brendan McKenna and Nick Bennenbroek in a June research note. “With foreign central banks tightening policy and explicitly signaling future policy changes, and the Fed remaining patient, we expect foreign currencies to attract capital flows.”
Others, like Brent Johnson, the founder and CEO of Santiago Capital, assert that the greenback will remain resilient for many years to come. Speaking in an interview with NTD Business, Johnson stated that the dollar would maintain its reserve currency status because the country maintains a stable government and the economy steers global commerce, adding that there are very few challengers on the world stage that could take on the United States on a global basis.
“A part of the reason for the U.S. dollar’s resilience is that it is the global reserve currency. And what that means is it’s not just used by the United States, it’s used by the whole world. It’s used for trade,” Johnson said, adding that the United States is the “sole superpower.”
Johnson added that the dollar has overcome the enormous monetary expansion since the 2008–2009 financial crisis. DXY is still at around 94.00, “despite all the money printing,” he noted.
“[I]f you go all the way back to 2008, since the global financial crisis, 12 years of crazy monetary policy,” he explained. “Over the last 20 years, the U.S. balance sheet, or the Federal Reserve balance sheet, has gone up by 900 percent. We’ve had QE1, QE2, Operation Twist, [and] COVID. You know, all of these different programs, the dollar index is higher than it was then.”
Michael Every, the global strategist at Rabobank Singapore, told Pezou that it is important “not to read too much into fluctuations in the U.S. dollar FX reserve holdings.”
“Nobody is pricing things in other currencies, or trading in them, or planning in them—yet. It will take a far larger collapse in the U.S., and far more orchestrated efforts from any not-yet-viable alternative to see that change. So, put what we see down to noise and not signal!”
De-Dollarization Campaign
But can the greenback survive the escalating de-dollarization push that China, Russia, and Iran are leading? Moscow and Tehran desire to skirt U.S.-imposed sanctions, while Beijing officials have employed measures to propel the yuan in international trade.
Earlier this year, the People’s Bank of China (PBoC) published its annual RMB Internationalization Report (pdf). central bank proposed greater adoption for the yuan and digital yuan in cross-border transactions, supporting the government’s long-term objective of making the yuan viewed as a global currency.
U.S. dollar’s representation of bilateral commerce between Moscow and Beijing fell below 50 percent last year, down from 90 percent in 2015. Moreover, Moscow and Beijing have engaged in currency swap agreements since 2014, and Russia has set prices at its seaports in rubles, effectively shifting away from dollars.
This past summer, Cuba started participating in the global de-dollarization efforts. Cuban central bank confirmed that the island nation would no longer accept cash bank deposits in dollars due to tighter U.S. sanctions that prevent the country from using its dollars in foreign markets.
It had been anticipated that India would join the de-dollarization crusade. However, New Delhi has been resistant for economic reasons, fearing that it could upset Washington as it hopes to eventually sign a trade deal.
US Dollar in 2022
U.S. dollar has rebounded from its one-month low as investors focus on rate hike prospects and Treasury yields touching recent highs. Fed has stated that it is too early to begin raising interest rates, but the institution also warned about inflationary pressures. Fed’s dot-plot (pdf), which signals the central bank’s outlook for the path of interest rates, is split: one half thinks the fed funds rate will begin rising as soon as next year, while the other half forecasts rate hikes in 2023.
In the short-term, strategists project weakness in the dollar, should global investor risk sentiment increase and foreign bond yields rise. dollar’s long-term prospects, however, are up for debate among market analysts.
Pezou : US Dollar Reserve Currency Status Not at Risk: Strategists