The movement toward modern monetary theory (MMT), the divergent political transitions in the US, Europe and China, and the prolonged structural adjustment still ahead for the US service sector are likely to weigh negatively on the dollar for some time, according to Brandywine Global.
In 2020, the US dollar advanced nearly 9% in the first quarter before giving back almost two-thirds of its rally as of the middle of August and after declining nearly 5% at one point in the first quarter, the euro is now up 11% from its March lows.
At the same time, the Australian dollar fell 18% in the first quarter and has since rallied 25%, while the Mexican peso fell 27% in the first three months and since rallied 15% but unlike developed market currencies, emerging market currencies, in general, did not recover their losses yet.
Anujeet Sareen, Brandywine Global portfolio manager, said that the first longer-term theme that turned negative for the US dollar was political as a rapid expansion of the fiscal deficit, the Fed commensurately expanding its balance sheet and through the second quarter, US real personal income grew at its fastest pace ever.
“However, MMT is a longer-term negative for the dollar. Moreover, the current polling leader for the US presidential election, Joe Biden, is campaigning on a platform to raise corporate taxes. Just as the lowering of taxes boosted growth and the dollar in 2018, an increase in corporate taxes in 2021 will likely discourage capital inflows into the US, weakening the dollar,” Sareen said.
Following this, the political winds in Europe and China moved in different directions, with the eurozone taking an important step toward fiscal union and Germany recognizing the need to help member states without conditionality, and offered to assist the hard-hit countries of Southern Europe with grants and not just loans.
Meanwhile, Chinese authorities took a much more measured approach to using monetary policy to respond to the pandemic, with China rapidly expanding money supply and credit following the Global Financial Crisis (GFC) in 2008 and the commodity collapse in 2016.
Both periods, however, led to a rapid increase in debt levels and misallocations of capital, Sareen said.
“The second factor that has turned negative for the dollar is the more structural impact of the virus on the US economy. While a variety of factors explain why some countries experienced more significant outbreaks than others, one common factor appears to be the size of the service sector,” he stressed.
“We are learning through the corporate world to what extent employees can operate from home. We also are finding other ways for interacting, reevaluating commercial real estate needs, and seeing restaurants operate differently. These changes and others like them mean there are service sector jobs that are just not coming back, and that should hurt the U.S. more than economies that are more manufacturing heavy.”
But, according to Sareen, the US leadership in the technology sector would remain robust.
“However, these factors are more likely to limit the degree of US dollar weakness than change the overall negative path for the dollar ahead,” he added.
