The dollar looked poised to close out the year with a second consecutive monthly decline, consistent with the prevailing view that the stars have aligned for a 2021 characterized by a weaker greenback.
By now, the narrative (or, if you think your tasseography is more sophisticated than the next person’s, you can substitute “thesis” for “narrative”) is familiar. The Fed’s determination to keep real rates low and financial conditions loose, alongside fiscal largesse in D.C., will undermine the dollar.
At the same time, vaccine distribution across the developed world will usher in a return to normalcy, bolstering pro-cyclical assets. That should undercut the appeal of safe havens and reinvigorate global trade, travel, and commerce.
A weaker dollar feeds into the reflation trade, which can then feed back into more dollar weakness, in a virtuous loop — for risk assets, anyway.
There are variations on that narrative, but that’s the gist of it.
“Through the lens of US asset market outperformance, a consensus view into 2021 is that the US dollar is overvalued after a long stretch of American exceptionalism,” AxiCorp’s Stephen Innes said Tuesday.
“Fed rate cuts have eroded the USD carry advantage, while their new average inflation targeting framework should keep (real and nominal) rates low for several years,” he added, before noting that “simultaneously, a recovering global economy should weigh on the safe-haven dollar demand through various channels like higher stocks and commodity prices.”
When you throw in the Fed’s outcome-based forward guidance (on both rates and QE), along with the familiar twin deficit structural bear thesis, you’re left with a perfect storm for dollar weakness. Specs seem to believe it (figure above).
Note that I’m just parroting consensus here. As we all know, consensus narratives have a pernicious habit of going woefully awry, and they always (always) sound compelling ahead of time.
It’s only with the benefit of hindsight that the flaws show up.