US Dollar Gains Momentum as Economy Surges: Can it Keep Going?

At the end of last year, most analysts and investors predicted that the US dollar would depreciate this year due to the possibility of the US Federal Reserve changing monetary policy, but current market developments go in reverse. Since the beginning of the year, the greenback has been increasing in value thanks to the stability of the US economy and the flow of outside money into US assets.

The US dollar price is approaching the record high reached during the Covid-19 pandemic. Compared to the currencies of America's largest trading partners, the dollar is 17% higher than the average price of these currencies over the past two decades. So what keeps the USD strong and how long will it last?

The strength of the US economy supports the greenback

Broad-based indicators of continued strength in the US economy have fueled recent dollar gains. Meanwhile, traders across markets lowered expectations for the Fed to lower interest rates soon. Investors who were short dollars were forced to close their positions when they realized high US interest rates could persist for longer than expected, strengthening the US currency.

Key pillars of support for the dollar include productivity growth and US economic dynamism. Additionally, capital flows into US assets and domestic technological prowess in key areas such as artificial intelligence (AI) has helped cement the greenback's dominance as the world's reserve currency despite all the short-term ups and downs.

By maintaining the lead of the US economy, these strong fundamentals will reduce the impact of future Fed rate cuts on the dollar.

In recent weeks, major players have abandoned bearish bets on the dollar made last December. According to new data from the US Commodity Futures Trading Commission (CFTC), non-commercial traders, a group that includes hedge funds, asset managers, and speculative investors, has significantly reduced the number of short dollar positions.

Also this month, economists raised their forecast for US growth in 2024 to 2.1% and reduced the probability of a recession to 40%, according to Bloomberg's latest monthly survey.

Kiyoshi Ishigane, Director of Fund Management at Mitsubishi UFJ Asset Management in Tokyo, commented: “If US growth remains the highest among major developed markets and US interest rates do not fall much, there is certainly no reason for the dollar to weaken.”

The current productivity boom could insulate the US economy against a global slowdown. However, according to Barclays' Fiortakis, these short-term positive impacts for the US dollar are just a byproduct of a stronger underlying trend.

US assets attract capital flows from outside

The dollar's price increase this year is also notable because it took place at the same time as the rise of US stocks, helping to attract a stable supply of capital from outside for the US economy. Most recently, shares of Nvidia, the world's leading AI chip supplier, increased sharply after last week's impressive earnings report.

Those capital flows are indicative of stable, long-term capital returns for US assets, while also helping to provide support for the greenback.

This year, the gauge tracking the prices of Big Tech stocks, or the “Magnificent Seven,” which includes Nvidia as well as companies like Alphabet, Apple, and Microsoft, is up about 13% compared with a gain of less than 5%. % of a measure of global stock prices.

In a recent report, Goldman Sachs currency strategists said the outlook for strong returns from US assets is supporting the dollar.

In a separate report last year, Goldman Sachs estimated the share of US assets in global portfolio investments to rise to about 26% by 2022 from about 16% in 2005.

The outperformance of the US economy comes against a backdrop of sluggish growth in Europe and growing concerns around China's weakening real estate sector. In China, foreign direct investment last year increased to its lowest level since the early 1990s.

JPMorgan strategists predict the euro will weaken to 1 euro to 1.05 dollars by mid-year, from 1 euro to 1.08 dollars currently.

Although dollar dominance also has “side effects” for US multinationals, the greenback's strength will pressure their overseas sales.

But for other countries, expensive dollars increase import costs, increasing inflationary pressure. This puts pressure on monetary policymakers in those countries, forcing them to raise interest rates further to prevent capital flight.

With a strong economy despite 11 interest rate hikes in the past 2 years, the US economy has now escaped the recession scenario, and the headache for investors has now been eased. In addition, technological strength in important fields such as artificial intelligence has helped attract foreign capital to US assets, making the USD even stronger.?

What could cause the USD to fall sharply in the future is the Fed cutting interest rates aggressively. However, with the latest inflation data showing that CPI continued to increase in January and the stance of patiently waiting for clear signals before taking action from the Fed, the USD will remain strong and maintain its current upward momentum.