Oct 9 2024: The U.S. dollar surged to its best week in two years, once again demonstrating the difficulty of betting against the currency when global forces resist letting it fall.
The DXY index, which measures the dollar against major global currencies, jumped more than 2% last week. This sharp turnaround surprised many speculators who had shorted the dollar, expecting it to weaken. While the rally was fueled by a strong U.S. employment report and revised expectations for Federal Reserve rate cuts, the dollar’s recovery began earlier in the week, with the payroll data merely amplifying the momentum.
The primary driver behind the dollar’s renewed strength has been signals from central banks in Europe and Japan that any Fed rate cuts would be met with similar moves from them. Major central banks around the world have been aligning their monetary policies with the Fed’s easing, as seen after the Fed’s significant 50 basis point rate cut last month, which kicked off a projected 250 basis point easing cycle.
Following this, central bank leaders from the European Central Bank (ECB), Bank of England (BoE), and Swiss National Bank (SNB) hinted at their own plans for accelerated easing. Although the Bank of Japan (BoJ) had initially pursued a different policy direction, recent comments from the BoJ and Japan’s new prime minister suggested a pullback from plans to raise rates.
In addition, interventions from the SNB to cap the rise of the Swiss franc, currency market interventions by the Reserve Bank of India, and a rise in China’s foreign currency reserves have all contributed to halting the dollar’s anticipated decline.
“Staggering” Demand for U.S. Assets
Beyond central bank actions, the robust demand for U.S. assets by private overseas investors has been a key factor supporting the dollar. Kit Juckes, a currency strategist at Societe Generale, expressed surprise at the dollar’s resilience despite the Fed beginning to cut rates. Historically, the dollar’s previous multi-year rallies were reversed once the Fed commenced easing, but that hasn’t been the case this time.
Juckes pointed to Japanese trust funds resuming purchases of U.S. Treasuries and rising overseas demand for U.S. dollar call options as evidence of an “exceptional” appetite for U.S. assets. This insatiable demand has kept the dollar overvalued, with its real, broad trade-weighted index about 30% higher than levels seen a decade ago. This growing exposure to U.S. assets has raised concerns about global economic imbalances reminiscent of the early 2000s.
Juckes highlighted that foreign investors have increased their net holdings of U.S. assets by an astonishing $40 trillion since 2020, making the continued thirst for U.S. investments all the more striking. He emphasized that while a weaker dollar might help address some global economic imbalances, the lack of confidence in domestic policies and markets elsewhere has driven investors back to the U.S.
Notably, U.S. investors have shown little interest in underperforming foreign markets, as seen in the net outflows from global equities in U.S. mutual funds, a trend that has persisted since the Fed began raising interest rates in March 2022.
What Could Shake Confidence in the Dollar?
While geopolitical risks are elevated, they tend to boost safe-haven demand for the dollar, making U.S. assets more attractive due to their scale and liquidity. However, domestic political uncertainty, particularly the outcome of the U.S. presidential election, could influence investor sentiment.
A potential return of Donald Trump to the White House in the November 5 election may raise concerns, particularly given his past support for a weak dollar and his calls for more political control over the Federal Reserve. Despite this, the global demand for U.S. assets and the dollar remains robust, even as the race for the presidency remains tightly contested.