Irrespective of whether the rally in risk assets extends into 2020 amid a steady (if less-than-spectacular) improvement in the global macro environment, Goldman doesn’t see a “significant short opportunity” in the greenback.
The bank’s assessment (as delivered in their 2020 FX outlook) is straightforward and dare we say “elegant”(?)
The question mark is there because while there’s definitely “elegance in simplicity” (so to speak), not everything that’s simplistic is elegant. We’re going to give Goldman the benefit of the doubt, though. The bank’s take on the greenback’s prospects in 2020 is well-articulated, whether or not it turns out to be correct.
(Goldman)
As you can see, the bank expects mild depreciation pressure in the new year – specifically, Goldman sees scope for the dollar to fall by around 1.5% to 2% on a trade-weighted basis.
Essentially, the bank presents the situation as a tug-of-war between a resilient US economy and an improving, risk-friendly outlook globally. The former argues for a stronger greenback, the latter for a weaker dollar.
Goldman frames this as “a tale of two dollars”. The “domestic Dollar” acts as any currency does – it rises and falls as the domestic economy waxes and wanes relative to the economies and markets of other nations. The “international Dollar”, on the other hand, is defined by a different set of dynamics. To wit, from Goldman:
The Dollar denominates the world’s most important risk-free asset, most cross-border lending to emerging markets, and an outsized share of global trade. These features create an inverse correlation between the strength of the Dollar and the health of the global economy: the Dollar tends to rise when global growth falters or markets wobble, and it tends to fall when global economic activity turns up or investor risk appetite improves.
Again, there’s nothing particularly profound about that, but the very fact that it’s foundational by definition means can never be repeated enough or overemphasized.
Here’s a simple chart that illustrates the point:
“The bounce in the trade-weighted Dollar in late 2017 as markets priced in tax reform is a good example of a domestic Dollar-led environment”, Goldman’s Zach Pandl writes, before juxtaposing that with “the Dollar rally in August 2019 [which] reflected the currency’s international role [as] investors fled to US assets even though the escalating trade conflict might damage US growth”.
The implication is that the bank’s take on global growth in 2020 (i.e., that things should generally stabilize) points to slight downward pressure on the “international Dollar”, given higher cross-border capital flows and less demand for the world’s safe haven asset par excellence (USTs).
And yet, the bank expects the US economy to perform well on a relative basis next year (i.e., versus Europe and China). That relative outperformance should bolster the greenback just as it did in 2018, especially if Fed policy looks “hawkish” compared to an ECB that’s likely to remain in easing mode for the foreseeable future and a PBoC that will be compelled to persist in guiding rates lower in order to cushion the economy, which will likely decelerate further (i.e., to a sub-6% growth rate).
A serious fiscal push in Europe (perhaps spurred along by Christine Lagarde) or a sudden inflection in the Chinese economy could change the game, but Pandl says that at least in the near-term, “the US economic backdrop looks significantly sturdier than that of two of its largest trading partners”.
Of course, there are myriad other factors that could play a role, including and especially the dynamics discussed at length over the past several months by Deutsche Bank’s Stuart Sparks, who has argued the the Fed will be forced to cut rates more aggressively in order to avoid importing disinflation. And then there’s America’s worsening fiscal trajectory, although that’s not expected to be a stumbling block for the greenback anytime soon, even if it probably should be.
Perhaps the most important thing to keep in mind in all of this is that all else equal, a weaker dollar is conducive to easier global financial conditions, and as we were reminded in 2018, that matters – a lot.
