The Dollar's Dominance

For years, I have been known as the reverse indicator. The more certain that I am that something is going to happen, the more likely the opposite will occur. This does nothing for my self-esteem, but I am consistent…and clients who pick up on the signaling have made a lot of money during my career.

A variant of my curse extends to travel. Statistically speaking, my flights are more likely to be delayed and my seats are more likely to be situated next to a screaming child. Once on the ground, the dollar is almost guaranteed to be weak against the home currency of any foreign country I am visiting.

On that latter front, my losing streak has come to an end…in a big way. The American dollar has been soaring in value over the past few months, briefly passing parity against the euro earlier this month. But while this trend has been good for me personally, it has introduced considerable discomfort elsewhere.

The United States is a country with 9% inflation, rising risk of recession, a massive trade deficit, substantial political strife, flagging stock markets, and national debt that is equal to 100% of gross domestic product (GDP). That would normally be the formula for currency depreciation, not near-record strength.

The conundrum is resolved with the following observation: currencies are graded on a curve. They have value relative to one another, not on an absolute scale. While America is hardly in an ideal economic place, other countries are faring even more poorly. Inflation and recession risk are higher in Europe; activity in China has been limited by their zero-COVID policy; and the war in Ukraine has prompted a rush to safety among global investors. U.S.-dollar based assets remain the world’s leading safe haven.

Chart 1: U.S. dollar index & one year government bond yields

On that latter front, the U.S. has become even more attractive. For many years, international investors paid a price for parking their funds here: short-term American interest rates have been anchored near zero for most of the past fifteen years. But U.S. yields have broken away from the lower bound in a substantial way. Overnight interest rates will likely be 2.5% by the end of July, and are heading even higher from there. Yields on American government bonds are now well in excess of those available in other developed markets.