Photo by Sharon McCutcheon
The US dollar has been depreciating since the financial markets managed to cope with the turmoil caused by the pandemic during February and March with the assistance of the Federal Reserve. The Reserve’s accommodative monetary policy and the federal government’s expansionary fiscal policy both played significant roles in the economy and the dollar’s value.
Overall, these policies have led to a decline in the dollar as the relief packages approved by other nations, including the European Union and China, have paled in comparison to the more than $5 trillion the US government injected into the economy in a matter of months.
The US dollar index (DXY) – which tracks the relationship between the dollar and a basket of various foreign currencies – portrays the extent of this depreciation. It makes clear how the greenback depreciated more than 10% between mid-March and early-September, although certain events appear to be putting some sort of pause to the downfall.
In the following article, Dr. Jasdeep Singh will share his views on the US dollar including an assessment of whether the greenback is currently a good store of value in light of recent events.
Inflation – a looming threat to your buying power
Basic economic theory states that a large injection of inorganic money that is not supported by an increase in productivity usually leads to higher levels of inflation.
Considering this, it is highly likely that the government’s recent decision to inject trillions of dollars to the economy to keep it afloat during the fallout caused by the Cororna-19 virus could push prices up, although that is an overly simplified statement for what is a very complex situation.
In fact, the Federal Reserve itself has failed to achieve its long-dated 2% inflation target for years and this could be the first hint that pushing inflation up in the United States may be harder than it seems.
That being said, it is still plausible that, in the long run, the US economy may have to deal with the undesired effects of higher inflation and investors should be prepared for this.
One way to do that, according to Dr. Singh, who is an MBA candidate from the University of Connecticut, is to increase the percentage of equities – i.e. stocks – in your investment portfolio. Equities have provided better protection against inflation than bonds due to their variable income generation capacity – which fluctuates alongside with corporate earnings.
Another way to do this is to keep a percentage of your holdings in other strong currencies like the Swiss Franc and the euro, both of which could serve as a hedge against a deterioration in the buying power of the US dollar.
Could the dollar rebound from these low levels?
Another scenario to keep an eye on is a potential rebound of the dollar amid a deteriorating economic outlook from Europe as COVID-19 cases have spiked in the region again. The re-emergence of the virus is triggering worries of a potential second wave of lockdowns and restrictions that could endanger the prospects of a recovery and, in consequence, the strength of the euro.
In this scenario, the uncertainty caused by the whole situation and the weaker macro environment of European countries could trigger a flight-to-safety move towards the US dollar and US Treasury bonds – which has been regarded as a safe haven for decades.
If such a shift were to occur, the US dollar would surge to new heights, although it is hard to tell how high as the expansionary policies of the US governments are likely to stay for the next few years, which puts a sort of ceiling to the dollar’s potential appreciation against other currencies.
The degree of monetary and fiscal expansion that the US government has been embarked on as a result of the pandemic has pushed the dollar to the brink.
Although the situation in Europe could level up the playing field, with the US election coming and since the virus situation persists, it is highly likely that another wave of fiscal relief will be pushed to Main Street. This will cause the dollar to remain weak – although stronger than it was a few weeks or months ago.
At the moment, since inflation seems to be under control, the dollar still holds its buying power domestically.
However, investors should consider diversifying their holdings by incorporating other currencies into their portfolio as a way to hedge their net worth against further depreciation in the greenback if the economic downturn caused by the virus endures for longer than expected.