Pandl has a “structurally negative” view of the dollar over the next three years. Goldman expects the current account deficit to peak at 4.4% of gross domestic product by the end of 2021. That’s more than the median forecast by forecasters, who estimate it will climb to 3.6 % of GDP this year, up from 3.09% at the end of last year and the largest since 2008.
If Goldman’s view on the greenback is correct, it would suggest that it is only a matter of time before foreign investors seek higher-yielding international assets, which would undermine the strength of the dollar and could lead to a longer term structural decline than many predict. For emerging markets, it could also mean stronger economic growth as a result of the US dollar’s inverse correlation with commodities, rising local stock prices and the potential deflation of dollar-denominated debt.
In the US fixed income market, 10-year Treasury yields are around 1.62%, which is higher than most developed markets, but significantly lower than the 3% investors get for Chinese and Mexican bond equivalents. And while the U.S. stock market continues to hit record highs, Goldman predicts a decline in stock returns relative to non-U.S. Markets over the next year – and he expects the deficit will also deflect them. dollar flow.
This is not, however, a consensus point of view. Stephen Jen of Eurizon SLJ, for example, believes that economic growth in the United States will drive demand for the greenback more than talk of a growing deficit and a low-yielding environment will hamper it. Bank of America agrees, saying deficits could weigh on the dollar in three to five years, but not now when the economy beats its global peers.
The key to this is recovery from the pandemic. The United States is leading major economies in inoculating their people, paving the way for business reopening. Economists predict that the gross domestic product of the United States will grow by 6.5% this year, compared to 5.1% on average for developed economies.
“A strong US economy should attract enough global capital to easily finance its large external deficit and in turn support the dollar,” Jen said. “Higher economic growth will mean more profits for US businesses and higher inflation, both of which suggest a stronger dollar.”
Those in Jen’s camp argue that when US assets are attractive to the world, the dollar has the capacity to strengthen even as the current account deficit widens. Indeed, foreign investors need dollars to invest in American titans such as Amazon.com, Google Parent Alphabet, and Facebook – all of which are listed on the US stock exchanges.
It is not without precedent. In the 1990s, the US currency rose amid a growing deficit as the rise of tech startups attracted just about everyone. And during the 1980s, high nominal interest rates attracted foreign investors as former Federal Reserve chief Paul Volcker raised the target rate to 20%, helping to prop up the greenback. while the current account deficit increased.
Admittedly, opponents point out that the dollar weakened when the US current account deficit widened in the mid-2000s. But Morgan Stanley says his historical analysis shows it is not clear whether such a relationship holds. over time. In a corresponding study of 28 currencies, the relationship between exchange rates and deficits was mixed, strategist Matthew Hornbach and colleagues wrote in a report.
“With most US trade being billed in USD, higher imports should not generate weakness in USD,” they wrote. “Rather, it will be the capital account that will determine the US dollar, that is, how will foreign investors react to the influx of dollars.”
The latest US net international investment position tracking data shows the measure is currently the most negative on record. This indicates that foreigners’ investment in the United States most exceeds that of Americans in assets abroad.
That said, the dollar carries more and Deutsche Bank thinks there is a major reason to be particularly worried about the external deficit.
“Its counterpoint is a large budget deficit,” which could prove to be persistent, especially in light of the challenges of containing it in the American political system, wrote Alan Ruskin and his colleagues.
These concerns take into account the bank’s forecast that the euro will climb to 1.30 against the dollar by the end of the year, from around 1.22 on Thursday, and end at that level in 2022. Meanwhile, leveraged investors remain bearish on the currency after switching to a net. -long position in early May. They have been bearish for 10 of the past 16 months.
“A country cannot have a high current account deficit forever,” said Athanasios Vamvakidis, head of G-10 foreign exchange strategy at Bank of America. “To reduce it, you need a weaker currency to reduce imports and increase exports. At some point, it will happen. “
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