by NGOC ANH 18/10/2021, 11:06

Not so exceptional for USD strength

There has been a theory that US ‘exceptionalism’ will permit a significant rally in the dollar against other advanced-country currencies.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy said that there would be no evidence that relatively strong US growth will lead to dollar strength. 

However, Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said there are two main problems with this. The first is that the US is not that exceptional. The second is that, even if it were, there’s no guarantee that it would create dollar strength.

Perhaps the first place to start is to ask, what do people mean by exceptionalism? Mr. Steve Barrow said most would see it as meaning a stronger growth rate and, on this score, the US does seem well placed. GDP has recovered all the output lost during the pandemic while many other countries are still short. If we take the euro zone, for instance, its GDP is still around 2.5% short of pre-covid levels (which we take as Q4 2019). But we have a number of problems with just using simple GDP growth. The first is that there’s no FX theory to our mind that suggests stronger growth equates to stronger currencies. If that were the case fast-growing countries in Africa, for instance, would have the strongest currencies, but often they have the weakest. This is because strong growth can come with adverse consequences, such as high inflation and weaker trade and, at the moment, the US has these in abundance.

If we compare the US with the euro zone again, we see that core CPI price inflation has soared to 4% right now from 2.3% at the end of 2019. In contrast, euro zone core CPI inflation has risen from just 1.3% to 1.6% over the same period. Of course, the rise in inflation has common characteristics such as supply-chain problems and surging commodity prices, but we also suspect that the US economy has been run a little too hot in these circumstances, and that’s created more of an inflation problem. Trade data backs this up, for while the US current account deficit has grown a massive 84% since the pandemic the euro zone has actually seen its surplus rise by 39% over the same period.

Another point is that stronger US growth has not seen more workers pulled into jobs. Right now, US employment is some 97% of its pre-Covid levels while the figure for the euro zone is nearer 99%. While US growth is stronger than most of its peers, it has been ‘bought’ by huge fiscal stimulus. The government has spent over 25% of GDP so far on direct fiscal stimulus; a figure that’s well above just about all other nations. In the euro zone, for instance, the eight largest countries have spent a simple average of 9% of their GDP on pandemic measures; or little more than a third of what we have seen in the US. On the monetary policy side, the ECB has not been able to stimulate with rate cuts in the same way as the Fed as it had hit the zero lower bound. QE has been greater in the euro zone than the US but we would still argue that the US’s better growth performance has been ‘bought’ on the monetary side as well as the fiscal side and, going forward, both of these sources of stimulus will weaken significantly.

The second issue Mr. Steve Barrow mentioned is that there’s no evidence that relatively strong US growth will lead to dollar strength. Again, if we focus on euro/dollar, it is very common for US growth to outperform the euro zone. Since EMU started in 1999, euro zone growth has only outperformed the US 30% of the time. But despite this deficit, the euro is still trading at the same level today as it did when it first came to life. What’s more, the bulk of the past 22 years, or so, since EMU started have seen euro/dollar trade above this opening rate; again, giving a lie to the fact that GDP underperformance undermines the euro. Looking ahead, the US is expected to outperform the euro zone. The IMF’s latest forecasts, for instance, put US growth at 6% this year and 5.2% next year compared to 5.0% and 4.3% respectively for the euro zone. Could this be consistent with a stronger dollar? In fact, given supply constraints right now, Mr. Steve Barrow could argue that the growth that is slower, will be better because booming demand will leave supply further behind and cause even more inflation – which is known to be bad for a currency’s value.