Here’s Why The Dollar May Be Headed Higher For The Foreseeable Future

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Since the 2008 crisis, central banks have printed vast amounts of money, thereby, flooding the markets with liquidity.  This has led to an environment where there are record prices in bonds, stocks, and assets in general.

With the environment of loose monetary policy coming to an end in the US, while continuing globally, it should be expected that spreads between the risk-free rates will rise. Considering the global nature of capital, this could cause a re-allocation of capital, out of non-dollar assets into dollar assets.

 

Currently, there are $11 trillion held outside the US in dollar-denominated debt and companies are having to refinance them in an environment of higher rates and a stronger dollar. This makes it increasingly hard to refinance and weighs down on cash flow. Emerging markets, which have gone on a borrowing binge in the past decade, are especially vulnerable to these changes.

 

Furthermore, it should be noted that there will be defaults within this spectrum (foreign dollar-denominated debt) of borrowing. Data increasingly indicates that the quality of this debt has deteriorated in recent times. As the supply of dollars declines, this will lead to further upward pressure on the dollar. Currently, interest payments on the dollar-denominated debt amounts to a little under a trillion dollars.

Adding fuel to the fire, a strong reserve currency is deflationary by nature and will only further hasten the deterioration of the debt market, as firms face pressure from repricing. This is especially true for firms that deal in commodities.

Since the credit crisis, we have also seen dollar flows into emerging markets looking for higher returns. As yields on the risk-free rate rise to levels where the relative risk of holding US assets reduces, the flow of dollars will reverse, and we are most likely to see a rotation of assets, out of emerging markets, and into dollar denominated assets. This rotation will further intensify the dollar rally.

All of this is further exacerbated by a dollar-shortage. As budget deficits soar in the US, the issuance of extra treasuries is putting pressure on an already stretched dollar market.

A common question that arises is the reason behind a dollar shortage despite the fact that the Fed has printed trillions of dollars. This can be explained by the relative rise of debt in the same period that exceeded the amount printed by the Fed due to QE.

In conclusion, the macro environment sets the dollar to continue the rally as the macro environment favors dollars, with rising real interest rates, a dollar shortage, and a demand for dollar denominated assets, we expect the dollar to rise by at least 10-20 percent over the year.

View our interactive dashboard for our Dollar Expectations and modify the key drivers to visualize the impact on the dollar.

 

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