Why has the US dollar been so stable?

The US dollar has been very dull in recent years, particularly against the euro, where it has not strayed too far from the very narrow 1.05-1.10 range. The US dollar has undergone periods like this in past. But they don’t last forever and nor will this one. The only currency that’s moved significantly against the US dollar is the yen but even the huge volatility here has not spurred much action in the US dollar against other G10 currencies. Why has the US dollar been so stable?

That’s not an easy question to answer. One factor Steve Barrow, Head of Standard Bank G10 Strategy would point to is the normalisation that has happened in recent years after the huge disturbance of Russia’s invasion of Ukraine in February 2022. This invasion caused a hugely detrimental supply shock in Europe as energy prices surged while the relatively resource-rich US was far less impacted. This terms of trade discrepancy led to the expected rise in the value of the US dollar in 2022 but, as time has rolled on, so this terms of trade shock has dissipated and so, it seems, has US dollar strength.

We have seen huge volatility in the rates market more recently, but central banks have tended to move broadly together (with the exception of the Bank of Japan) and this has restricted the room for interest rate differentials to create strong trends in the developed currencies. This was the case when policy rates were rising, and we expect it will continue to be the case as policy is eased.

Of course, there is some room for variation; the Fed’s aggressive 50-bps rate cut to start the easing cycle has put some pressure on the US dollar but, by and large, Steve Barrow’s view is that monetary policy easing is not going to drive significant currency volatility, at least not when it comes to variations in interest rate differentials. There might be more scope for easier monetary policy, particularly from the Fed, to weaken the US dollar if riskier assets, like stocks, power ahead but, even here the downside for the US dollar may be limit ed.

Another point here is that, if we do see the US dollar weakening as a consequence of Fed easing, it seems likely that it will be most pronounced against ‘risk’ currencies, such as those in emerging markets, not other major currencies like the euro. This not just because we’d expect riskier currencies to outperform in a rate-cutting cycle that sees risk assets rise, but also because many major currencies are not offering very much, particularly the euro, where the economy remains moribund.

In other words, while Fed rate cuts and a ‘risk-on’ environment might be expected to lower the US dollar, the case for choosing the euro as the currency for the other side of the trade seems poor. The economy is still very weak and falling inflation seems likely to make the ECB cut rates by more and faster than the market anticipates. This observation talks to the idea that euro/dollar may stay range-bound even if the US dollar endures more pain against riskier currencies such as the aussie, Scandinavian currencies and, of course, many emerging market currencies. Hence, Steve Barrow feels it is wrong to look at the movements in euro/dollar as being indicative of the pressure on the greenback.

“It does not look as if the case for a significant slide in the US dollar against the euro is especially strong right now. Add to this the considerable uncertainty surrounding the US presidential election in November and it seems a time to hunker down, not push the boat out on the short-US dollar trade. For the US dollar to move significantly, we may need to see really significant divergence akin to that we last saw in 2022 when Russia invaded Ukraine and hit the euro zone’s terms of trade hard. But big terms of trade-type shocks could be in store if former president Trump wins a second term on November 5^th and goes ahead with his tariff plans. Hence, we’d see this as potential catalyst for a significant move in the US dollar, not monetary policy easing which is progressing in a similar fashion across countries,” said Steve Barrow.