The US dollar continues to slide in what is now referred to as the longest decline since 2010. Nevertheless, the US economy seems to be showing some positive recovery trends, as the total gains US stock market gains have reached 7% in the S&P 500 Index, outperforming Canada, Japan, UK, and Australia equity markets. Now that the end of the quarter is in sight, some new developments are to be expected. Investors, in an attempt to maintain appropriate risk levels and realign the market towards a more favorable value distribution. In order to do that, investors will be looking to sell over-performing currencies ( such as the US dollar) and buy those that performed weaker in the past quarter (such as the Australian dollar and the British pound). With the Bloomberg dollar declining by 0.2% on top of last week’s 0.5 % decline, experts are wondering what to expect from the USD in the coming months. 

Image by Gerd Altmann from Pixabay 

Why Is The Dollar Falling? 

Since March this year, the USD has been stuck in one of the longest periods of decline that the currency was ever subjected to, with an overall estimate of decrease reaching a total of 10%. Experts identify a number of reasons behind the US dollar’s sudden decline. 

First and foremost, one cannot overlook the state of turmoil to which America has been subjected throughout this year. Experts of the industry are largely divided over which factor should be regarded as the main catalyst of the dollar decline- some of the top foreign exchange firms name the US-China trade wars as the main driver behind the crisis, others blame the outbreak of the global pandemic and the inability of the US government to handle it adequately. On top of that, many are also referencing the wave of Black Lives Matter protests, the relative uncertainty of foreign exchange regulation and safety in the country due to political division, and the contrast between the US economy and the economies of other developed countries. Although no single factor has been singled out, it is safe to say that the combination of all those mentioned above has contributed towards the decline of the US dollar. 

Secondly, and, probably, more importantly, it was the decision of Federal Reserves to allow for the inflation to rise up to 2% that was mostly associated with the decline of the US dollar. The decision was made for the purpose of reaching the average inflation rate, facilitating economic recovery, and reducing unemployment. Although at first, the break-even rate has been increasing, amidst the increasing inflation expectations, following the period of stagnation it became apparent that the investors have little faith in Fed’s ability to maintain, or, let alone increase the inflation rates. Nevertheless, it should be noted that even in case of mild growth of inflation, both equity markets and long-term bond investors will be left exposed. 

Future Prospects - What To Expect Next?

At this point, trying to predict the future of the US dollar is more like reading tea leaves - an enormous amount of ever-changing factors makes it impossible to single out one solid future trend. However, there are some possible scenarios that one can consider, and we will assess them below. 

One of the most radical and dramatic scenarios is the US dollar losing its status of global currency reserve and being replaced by the euro or the Chinese renminbi. Although it is true that the USD saw its share of the allocated global foreign exchange reserve declined by 6% since 2015, it still accounts for a total of 60%, as opposed to EUR which is estimated by 20% and only 8% for renminbi. One can argue that the state of turmoil and political crisis in America, coupled with the growing number of COVID-19 cases can lead to the final fall of the US dollar. While possible, such a scenario is unlikely for the following reasons. Firstly, the political turmoil in the US is only temporary and mostly caused by the pre-election season, and it will probably pass as soon as the Presidential Elections are held in November. On the contrary, the eurozone is much more prone to the political crises, as well as facing public debt, unemployment, and being unable to protect itself from the economic shocks caused by the bank runs. In the case of the renminbi, despite its promising growth, capital controls and geopolitical considerations are likely to prevent China from occupying a strong threshold at the global currency market. 

The second and a much more optimistic scenario is that the dollar will prevail as the dominant currency, and will, eventually, pick up again. In this scenario, the dollar is likely to continue its record decline until the Presidential Elections are finally held in November. Following that, and coupled with the Fed’s efforts to sustain the inflation rates, as well as the general flexibility of the US labor market, the US economy is likely to make a relatively fast recovery and, by gradually increasing the production, increase the demand for the USD-based transactions. Furthermore, since over 10 trillion of the global borrowings and over 23 trillion of the global trade are denominated in the USD, the currency is not likely to give up its dominant position. 

The future is uncertain, but one can be sure that the world needs the US dollar, and what we are witnessing now is definitely not the end of it.