It was a particularly challenging year for the greenback in 2020, where the world’s reserve currency acted as a “safe haven” asset at the height of the March 2020 market volatility, only to fall over the remainder of the year. With the U.S. outpacing much of the developed world in economic growth in 2021, Treasury yields have been rising and the dollar has strengthened, bucking the consensus view for dollar weakness.
We view the “twin deficits” of the U.S. economy—the combination of the budget deficit and the current account deficit—as a long-term structural driver of a weaker U.S. dollar. As a historical net importer, the U.S. has usually carried a trade deficit (leading to a broader current account deficit in the process), while the flood of pandemic aid has stretched the budget deficit and ballooned the sum of the twin deficits to all-time lows as a percent of gross domestic product (GDP). As shown in the LPL Chart of the Day, changes in the twin deficits have been a relatively accurate predictor in the long-term trend of the value of the US dollar:
With the twin deficits reaching all-time lows, it’s hard to be bullish the US dollar over the long-term relative to its major counterparts. “The short-dollar trade has certainly been a frustrating one for investors this year, but the long-term trend continues to point lower,” added LPL Financial Chief Market Strategist Ryan Detrick. “However, a counter-trend rally like we saw in the first quarter might have been enough to flush out some of the crowded consensus for a lower dollar.”
U.S. economic growth has outpaced our developed nation counterparts to begin 2021, but expectations for growth in the rest of the world may be playing catch up. In particular, the 30-year German bund yield broke out to its highest level since the onset of the pandemic, suggesting growth expectations for one of our major trade partners may be on the rise.
A soft dollar has a variety of investment implications. While we continue to favor U.S. stock market exposure over developed international markets, investments overseas may benefit from the tailwind of the softer dollar. Meanwhile, commodities have historically benefitted from a weaker dollar, and may be positioned for further upside as economic activity in the rest of the world heats up. For more on our tactical market views, check out our April Global Portfolio Strategy.
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