How the US exceptionalism impacts US dollar

>> Reason for the US dollar’s rise against major currencies

There’s no doubt at all that the US economy is sweeping all other (G10) economies aside. Just whether this will lead to a material divergence in central bank policy remains to be seen. But even this exceptionalism itself might be seen as a source of dollar strength whether it provokes a divergence in policy or not. For surely stronger economies should have stronger exchange rates? Or should they? We say this because, if we look at the US dollar right now you could be forgiven for thinking that the US is not exceptional at all. This is because the US dollar has been very stable; not just recently, but going back to the start of 2023, a time when US exceptionalism was already flourishing.

In fact, we can go back much further than this. For the US dollar has basically traded sideways, albeit in a wide 50% trading range (in real effective terms), since floating exchange rates were adopted in the 1970s and yet this period has generally been one of US exceptionalism. For instance, US GDP per capita, which is a good measure of exceptionalism has steadily improved in the US relative to the likes of Europe and Japan. Why has this exceptionalism not produced a long-term uptrend in the US dollar rather than the sideways – but volatile – pattern that’s been in place all these years? The answer might like in the fact that there are what we might term ‘automatic stabilisers’ that counterbalance this exceptionalism.

One way to see this is to think about the very short-term and how the US dollar responds to data releases such as last Friday’s US payroll data. The data was stronger than anticipated and we might say that this is typical of an ‘exceptional’ country like the US while, less exceptional countries generally report underwhelming data. If the currency market moves on these data misses, then we might expect the US dollar to rise over time. However, the more US data out-performs expectations the more it tends to drag up these expectations the next time a piece of data are released. As a result, there comes a point when the data no longer outperforms the consensus even if the numbers themselves are no weaker than previous releases.

In essence, outperformance seemingly cannot become a permanent feature and nor can underperformance and hence the data’s ability to create long-term currency trends seems limit ed; there is a sort of automatic stabiliser at work. We can see a similar sort of mechanism when we think about asset flows such as stock and bond transactions. For besides the fact that US exceptionalism makes US equities appear quite expensive relative to others, there is also an FX factor as well.

>> Long term outlook for the US dollar

Steve Barrow, Head of the Standard Bank G10 Strategy said this would occur because US exceptionalism is most likely to mean higher US rates than we see in comparable G10 countries. Theory suggests this and history points the same way, especially if we compare the US to the likes of the euro zone, Switzerland and Japan. But relatively high US interest rates imply that the US dollar trades at a forward premium and this means that the asset bought by foreign investors – such as US stocks – has to deliver an even higher relative return in order to generate a hedged profit for the investor.

In short, there’s a sort of automatic stabiliser here too. Of course, the US dollar’s forward premium might push investors to buy US assets on an unhedged basis (while US investors in foreign assets will prefer to hedge) and this can lift the US dollar. Nonetheless, the truth seems to be that US exceptionalism does not seem to be garnering as much support for the US dollar as we might imagine. This could change in time, although we rather suspect that it will change the most, in terms of its implications for the US dollar, if and when US exceptionalism appears to slip and that’s partly why we are still biased towards a modestly lower US dollar over the longer-term.