The euro’s move to a 1-year high versus the dollar this week is a good excuse to briefly revisit the global value of the greenback. To help frame the discussion, let’s look at the Fed’s measure of the trade weighted dollar back to 2006. As a reminder, here are this index’s current key weights:
- Euro: 18.9%
- Chinese yuan: 15.8%
- Mexican peso: 13.5%
- Canadian dollar: 13.4%
- UK pound: 5.3%
- Rest of world: 33.1%
And here is the trade weighted dollar chart:
Three points on this:
#1: The 2020 COVID Crisis spiked the dollar to a level 19% higher than the 2008 – 2009 Financial Crisis, and “peak dollar” in each period coincided EXACTLY to the day of the S&P 500 low for both events. On March 9th, 2009 the trade weighted dollar index closed at 106.01, a level it would not see again until 2015. On March 23rd, 2020 the dollar index hit an all-time high of 126.47. It is 5.5% lower today.
Takeaway: a weaker dollar is confirmation that global investors feel the worst of the COVID Crisis has passed and validates the rally in equities off the March lows. Do not, in other words, worry that a weaker dollar is a warning sign about a sudden turn lower for US equities. History testifies to the contrary.
#2: If the dollar’s post-Financial Crisis experience repeats itself, the dollar should fall by another 13-14% over the next 2 years. The total move from 2009 to 2011 visible in the chart above was 19%, and we’ve seen a 5.5% drop already. The balance will happen more slowly, but in the context of a slowly recovering global economy it only makes sense for the dollar to weaken further.
Takeaway: this argues for dollar-denominated investors to allocate incremental assets to non-US capital markets. We have always argued that, on a fundamental basis, US equities are structurally better positioned than either EAFE (non-US developed economies in Europe, Asia and the Far East) stocks or Emerging Market equities. American indices like the S&P 500 have more exposure to Technology, for example, and less to Financials and Industrials. But a dollar that drops 13-14% in the next 2 years is both a financial and fundamental tailwind for EAFE and EM, and we certainly understand that may help these long-suffering slices of the global equity market finally catch a bid.
#3: Even a 20% drop in the dollar from its recent high only takes the trade weighted index back to 101, and as you can see from the chart it traded lower than that from 2010 to 2015. Should the dollar weaken further than its post-Financial Crisis experience, it will be a sign that the US economy has been more damaged by the COVID Crisis than the rest of the world. America by and large recovered from the Financial Crisis better than Europe, for example, which helped support the dollar after 2011.
Takeaway: currency values are always a relative game since they only represent its economy’s attractiveness vis a vis other options. The dollar benefited from the uncertainty around the global COVID Crisis, but the US will now have to “win the peace” to keep the dollar from losing more than a typical post-crisis decline in value. On balance we believe it can do so, but we also know markets are watching this indicator carefully and it will be easy to mistake a normal decline from one that signals something more troubling.