10 Major Investment Implications (and 32 charts!) of a Weak US Dollar

With the US dollar index recently having completed a so called “death cross”, we thought it would be a good opportunity to review the investment implications of a potential trend change in the USD. The “death cross” is a technical chart formation in which the 50-day moving average passes under the 200-day moving average. It is a simple measure of trend, but one that historically has preceded further weakness in the USD.

The “death cross” comes at a time when some fundamental forces seem to be suggesting a more durable downtrend in the USD is possible, as opposed to just a short-term reversal in trend. For example:

  • The US budget deficit as a percent of GDP may reach a new record in 2020 at 15-17%. The budget deficit as a percent of GDP is highly correlated with the level of the USD in that wider budget deficits are associated with a weaker currency.
  • The Federal Reserve has clearly signaled that it does not intend to raise rates until 2023 at the earliest, as the “dot plot” of individual Fed governors’ projections suggests. More Fed ease may also be on the way in the form of forward guidance, yield curve control, an inflation symmetry target, and/or a more permanent quantitative easing program. All else equal, these items support the case for a weaker currency.
  • The question is weak against what? In our view the euro is one contender. As the 4th chart below shows, the interest rate differential between the Fed Funds rate and the ECB deposit rate is no longer supportive of the USD since that differential has moved from 2.75% to just 0.75% in a matter of a few months’ time.
  • Furthermore, the Fed (so far) appears is creating more money than the ECB in its response to the COVID crisis. That is, the money supply in the US is growing faster than the money supply in Europe. This dynamic is supportive of a stronger euro vs the USD (see chart 5 below).
  • Finally, the unemployment rate in the US is quickly moving to parity with the Eurozone (see chart 6 below). In the past, as the unemployment rate differential between Europe and the US has closed, the euro has strengthened vs the USD.

Given the above, the likelihood of a weaker USD, against the euro and other currencies, seems more probable than in years past. This too is before even considering the implications of a more solidified political union within Europe. As such, examining the asset allocation implications of a weaker USD makes sense at this point, even if the trend is not fully entrenched yet.