The dollar is out of favor — perhaps you’ve heard.
When it comes to the greenback, the market is concerned about a veritable laundry list of ostensibly bearish developments including, but not limited to, the US government’s inability to corral corona (so to speak), the implications of the public health crisis for the world’s largest economy, and the read-through for fiscal and monetary policy.
This confluence of factors isn’t just weighing on the dollar, it’s raising questions about the currency’s reserve status, and dysfunctional politics in D.C. aren’t helping matters.
Fund managers polled by BofA are the most bearish on the dollar ever, a development the bank attributes “at least partly [to] expectations of some erosion of the hegemony of USD as a reserve currency”.
Given the above (and recent trends) it’s hardly surprising that leveraged fund positioning flipped for the first time in years last week.
The other side of that is obviously optimism around the euro, which has benefited handsomely from i) the region’s relative “success” at flattening virus curves after a harrowing few months and, especially, ii) the establishment of the jointly-guaranteed recovery fund, which marked the first step towards a fiscal union (see “A Good Slippery Slope“).
Some believe upbeat sentiment around the common currency is overly ebullient, even if the bullish case remains intact. The resurgence of COVID is one obvious risk. “Positioning just gets more extreme”, SocGen’s Kit Juckes wrote Monday, adding that “the recovery fund was a significant step in the right direction for Europe, and we have a very non-consensus view of Europa/US growth differentials that underpins a long-term bullish euro view, but as COVID spreads along the summer vacation hotspots in Europe, I still think this move has gone too far, much too fast”.
In any event, rampant bearishness around the dollar isn’t likely to abate completely until there’s some reason for the market to believe the fundamentals are poised to improve. The figure (above) shows positioning against real yields, the key driver behind greenback weakness and gold strength. Below, find positioning plotted with DXY, alongside the 7-day average of COVID cases stateside.
This is just another market dynamic that is inextricably bound up with the evolution of the virus and nations’ relative success (or, in this case, failure) to bring the pathogen to heel.
In America’s case, the lackluster COVID response is generally seen as emblematic of government dysfunction and, perhaps, outright political decay.
Although de-dollarization is a glacial process, one thing that could speed it up is the perception that the US is becoming ungovernable.
In the BofA survey mentioned above, some 40% of respondents said they anticipate USD reserves will decline over the next 12 months.
Heavy is the head that wears the crown, apparently.