Everything contributes to the weakening of the American currency. But not to the point of knocking it off its pedestal

Back to normal or the start of a sustainable regime change? This summer, the rapid slide in the dollar was one of the major market trends. The greenback did not just weaken against the euro, touching 1.20 in early September, but against all major currencies, as shown by the 7% drop in the DXY index in four months. A downturn whose speed has even led some economists to question the risk of losing the reserve currency status enjoyed by the American currency.

If we put it into perspective, this correction seems limited by historical standards, and the dollar is still considered overvalued. The DXY index has only returned to its early 2018 level. There is still a long way to go before recording a plunge comparable to those that followed the explosion of the Internet bubble in 2000 (-32% until 2004) and the famous Plaza Agreements of September 1985, where the major G5 countries coordinated to weaken the greenback by almost 50% in 18 months. The summer downturn can be explained by a renewed appetite for risk among investors after the shock at the beginning of the year, but also by the increasingly accommodative policy of the Federal Reserve. The yield differential in favor of the United States has narrowed considerably, by almost 140 basis points for example between the American and German 2-year rates.

Political uncertainty is also at play, whether it is the result of the American presidential election or the inability of Democrats and Republicans to agree on extending household aid. The rampant indebtedness of the United States and the headlong flight of the Federal Reserve raise the most questions. The Congressional Budget Office, the fiscal arm attached to Congress, projects that federal public debt will jump to 98.2 percent of U.S. gross domestic product in 2020 (+20 points), and then to 105.6 percent of GDP in 2022. A debt that is now largely monetized. By setting a target of average inflation over the long term at the end of August that can be exceeded for as long as necessary, the Federal Reserve has anchored the low level of rates, while raising the risk of being overwhelmed by inflation — a phenomenon that is currently a fantasy. “The Fed's stimulus has been much greater and its balance sheet expansion the highest among major central banks, Barclays analysts note. Adopting an average inflation target, in a world where other central banks maintain a specific target, could lead to structural weakness in the dollar by allowing excess inflation and a relative decline in real rates.

Heavyweight

Most economists therefore expect the greenback to weaken further, as did the panelists interviewed every month by L'Agefi Quotidien. In the short term, some of them still point to its stabilization potential. “There were a series of poor American statistics, due to an increase in virus infections during the early summer lockdown, but this trend should be reversed, as the number of infections is now rising sharply outside the United States and is falling sharply at the domestic level,” said Ben Randol, foreign exchange strategist at Bank of America. At HSBC, Paul Mackel even contests the idea of a link between economic performance and currency movements in recent months, stressing that economic surprise indicators have been better across the Atlantic than in Europe. “Given the volatility of economic indicators, financial markets have apparently ignored many traditional fundamentals, and allowed the trading community to build speculative positions to extreme degrees,” says the HSBC foreign exchange strategist, with high selling positions on the dollar that will have to subside. In the medium term, the factors mentioned — monetary expansion, the credibility of fiscal policy, the growth of external debt — would continue to weigh on. From there to the motto falling from its pedestal, there is a step that many refuse to take. US Treasuries remain the safe and liquid asset par excellence, and the dollar accounts for 62% of global foreign exchange reserves, a supremacy that neither the euro nor the yuan are about to challenge. The February-March rush to the greenback, in panic markets, is there to