Please find another edition of Q&A with BCA – and thanks to BCA Chief Economist, Martin Barnes, for taking the time to answer this question.
Q. There are two prominent factors that determine foreign currency behavior and would appear to be in conflict:
- Gradually improving structural economic trends within the USA that are related to the revolution in domestic manufacturing and oil and gas production. These forces would: (a) Reduce current account deficits; and (b) Boost capital flows because of the growing attraction of the USA as an investment destination. USD Appreciation
- The alternative view relates to “risk-on” and “risk-off” strategies: Broad strengthening of the US economy should boost growth in the global economy. As global economic conditions improve/global risks subside, the risk-on trade would boost the euro (and other currencies) versus the dollar.
Which of these two conflicting forces would be dominant with respect to the USD?
A. The dollar outlook is quite tricky because, as you noted, various cross currents will be at work. I would not attach that much emphasis on the so-called manufacturing renaissance or the shale gas and oil boom. Yes, the energy component of the deficit will drop further, but the trade balance remains very sensitive to the overall growth rate because imports are tightly correlated with domestic demand.
The other factor you did not mention was monetary policy, and we generally assume that the Fed will remain more pro-active than the ECB when it comes to promoting growth. So that should be dollar bearish.
Finally, I worry that at some point, markets will do to the US what they are doing to Europe and that would also be dollar bearish. This was covered in a report on the dollar that my colleague Peter Berezin recent published in The Bank Credit Analyst.
I agree with him that the dollar is more likely to be a weak than strong currency in the coming years. (tweet this!)
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