• Multi-Asset & Macro
  • Economic Research

What’s up with the dollar?

Rising US interest rates have failed to arrest a long-running decline in the dollar, now into its fourteenth month. Ahmed Behdenna looks at some of the reasons why.

A picture of four rolls of US Dollars

Little more than a year ago the US dollar was riding high, fuelled in part by hopes the new president, Donald Trump, might succeed in achieving the seemingly inconsistent aims of cutting the country’s massive trade deficit while turbo-charging economic growth.

Trump’s positive effect on the dollar was short lived. After in December 2016 hitting its highest level in more than 13 years on a trade-weighted basis, the currency has been on a steady decline ever since.

Unusually, the fall has coincided with a sharp rise in US bond yields, which has pushed interest-rate differentials in the dollar’s favour against the euro and most other leading currencies.

line graph showing the spread between US 10yr and German 10yr Bonds overlaid with EUR / USD data

As the chart above shows, since the end of June 2017 the spread between US and German ten-year government bond yields has widened by 28 basis points; yet in that time the dollar has fallen by ten per cent against the euro. That marks a clear reversal of the relationship that held for the previous eight years.

All talk, no action?

There are a number of factors behind the dollar’s weakness, none of which seem likely to disappear in a hurry.

Ever since former US Secretary of the Treasury Robert Rubin first talked about a ‘strong-dollar policy’ in the late 1990s, successive US administrations have been keen to talk up the currency. The policy was seen as a way to assure investors Washington would not intervene in exchange markets to debase the dollar.

With the Federal Reserve free to conduct monetary policy independently of the US executive, financial markets were well aware that in reality the strong dollar policy amounted to little more than fine words.

Nonetheless, with successive administrations mindful of the need to attract foreign investment to fund the country’s budget and current account deficits, those words were seen to matter. However, suddenly financial markets are questioning whether Washington’s long-standing commitment to a strong dollar is as firm as it has been for the past two decades.

Sentiment towards the currency deteriorated sharply in January when the market latched on to remarks from US Treasury Secretary Steven Mnuchin, who claimed a weak dollar was good for US trade. His remarks prompted the currency’s biggest one-day decline in ten months, pushing it to its lowest level since December 2014 on a trade-weighted basis.1

The slide came despite Commerce Secretary Wilbur Ross just hours later insisting the US administration was not abandoning the strong-dollar policy.2 The following day Mnuchin said his remarks had been taken out of context, stating that while he was not concerned by its current weakness, ultimately in the longer term he believes in the strength of the dollar.3

As for Trump, having in July 2017 told The Wall Street Journal “lots of bad things happen with a strong dollar”,4 in January of this year he said he “ultimately” wanted to see a strong dollar.5

Fixing the deficit

Although the market arguably overreacted to Mnuchin’s comments, the size of the move demonstrates the fragility of sentiment towards the dollar. Furthermore it is not hard to see why the dropping of the strong-dollar mantra and the mixed messages coming out of Washington are leading the market to suspect the policy has shifted to one favouring benign neglect, if not outright depreciation. A weaker dollar, after all, would probably be the easiest route to cutting the US’s record trade deficit.

Trump’s determination to achieve that goal can be evidenced by the raft of protectionist measures he has pushed through as he tries to make good on his ‘America First’ agenda and his vows on the campaign trail to repatriate the jobs of rust-belt supporters.

The US has already pulled out of the Trans-Pacific Partnership – a trade deal with 11 other countries bordering the Pacific Ocean – threatened to scrap the North American Free Trade Agreement with Canada and Mexico, and stalled negotiations on the Transatlantic Trade and Investment Partnership with the European Union.

Then in January the US slapped tariffs of as much as 30 per cent on imported solar equipment and 50 per cent on washing machines. While the tariffs aren’t directed specifically at China, it is the world’s biggest producer of solar panels and exported 21 million washing machines last year worth almost $3 billion.6

Whereas a strong US economy, coupled with protectionist measures designed to get the US trade deficit down, might in other instances have been expected to boost the dollar, this has failed to happen for a number of reasons.

Firstly, thanks to the renewed vigour in the economy, the country’s trade deficit has actually begun to rise, in December swelling to a nine-year high of $53.1 billion.7

Worse still, the Trump administration is embarking on a huge fiscal stimulus at the precise moment fears the US economy is overheating have begun to emerge. That raises obvious concern imports or inflation, and quite possibly both, could be set to spike. Either could spell trouble for the dollar.

The federal government deficit, having already increased 13 per cent to $666 billion in the fiscal year to September 2017, is widely expected to balloon after lawmakers recently pushed through a series of spending increases hot on the heels of deep tax cuts enacted earlier in the year.8 The deficit looks set to virtually double to $1.2 trillion by fiscal 2019.

That would already be more than five per cent of gross domestic product: if the tax cuts passed in December are made permanent, which looks likely, America’s budget deficit is forecast to exceed $2 trillion in less than a decade. US public debt, meanwhile, looks set to soar to its highest level since the Second World War. US Federal Debt owned by the public currently stands at 76 per cent of GDP. After factoring in the tax cuts enacted in January, to current Congressional Budget Office projections made last June, that ratio looks set to climb to around 100 per cent of GDP by 2027.

An eye for an eye

With the Fed simultaneously in the process of shrinking its balance sheet, the US is more reliant than ever on foreign savings to fund its $14.5 trillion debt mountain. China is the largest holder of US Treasuries, followed by Japan, with the two countries between them holding more than $2 trillion of US securities. All told, foreign investors hold $6.35 trillion in US government debt, more than twice as much as in 2008.9

Beijing, having expressed “strong dissatisfaction” with the US tariffs, is widely expected to respond with tit-for-tat measures. The risk is that these developments will curb a key source of demand for Treasuries, which is one plausible explanation for the recent sharp rise in US bond yields.

More worryingly for the dollar, Trump’s actions call into question its ability to act as the world’s de facto reserve currency over the long term. Already there is some evidence to suggest the world’s central banks have been diversifying their holdings of foreign exchange reserves away from the dollar.

According to data from the International Monetary Fund, the dollar’s share of global foreign exchange reserves fell from 66.5 per cent at the end of 2005 to 63.5 per cent at the end of September 2017 – a period when the dollar’s value on a trade-weighted basis was unchanged.10

The Reserve Bank of Australia reckons the share of total reserves allocated to non-traditional reserve currencies rose from two per cent in 2009 to almost seven per cent last year.11

Given the composition of foreign exchange holdings can be volatile, in large part due to fluctuations in exchange rates, it would be wrong to conclude from these figures that the dollar is losing its status as the world’s pre-eminent global reserve currency.

After all, the sharp rise in US bond yields seen in recent weeks will boost the comparative attraction of US assets to foreign central banks, desperate to get a return on their foreign exchange reserves.

However, given the risk that the US is embarking on a reckless expansion of fiscal policy at precisely the wrong time, it is not clear interest rate differentials are sufficiently in the dollar’s favour to encourage a swing in sentiment from the bulk of private sector investors.

That could change if the Fed were to tighten policy sufficiently aggressively to stamp out the threat of inflation. But given such a move does not look imminent, there is little reason to bet on an early recovery in the dollar’s fortunes just yet.


1 ‘Mnuchin backs weaker dollar in break with tradition’, Financial Times, January 2018

2 ‘Commerce Secretary Wilbur Ross: The US is not abandoning its strong dollar policy’, CNBC, January 2018 

3 ‘Mnuchin Defends Weaker Dollar Comments’, Bloomberg January 2018

4 ‘Full transcript: Trump’s Wall Street Journal interview’, Politico, August 2017

5 ‘Trump says dollar will get “stronger and stronger”’ CNBC, January 2018 

6 ‘Trump imposes steep tariffs on imported solar panels and washing machines’, Guardian, January 2018

7 US Department of Commerce, Bureau of Economic Analysis

8 Congressional Budget Office

9 US Department of the Treasury

10 International Monetary Fund, currency composition of official foreign exchange reserves database

11 Reserve Bank of Australia, Trends in Global Foreign Currency Reserves, report by David Sunner, Q3 2017

Related views

Important information


Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.