The US dollar has been on the decline since the onset of the Covid-19 pandemic, partly due to an expected slowdown in the US economy’s growth.
The USD index has lost some 9% since March with the depreciation particularly rapid against European currencies, says Tai Hui, Asia chief market strategist at JP Morgan Asset Management, on August 5.
Highlighting several reasons behind the recent downturn of the USD, including a high valuation in recent years, a sizable trade deficit in the US economy, and the country’s sharp surge in fiscal deficit, Tai adds that while the USD has been able to “stay strong” until recently, there are new factors that may cause the reversal of its bullish trend.
“[The] US economic outperformance relative to the eurozone and Japan is no longer guaranteed given the damage from the Covid-19 pandemic,” he says.
“As a result of narrowing of economic performance, USD interest rates are also converging to other developed economies’ interest rates, which means that the USD is less appealing and investors would look to make deposits in other currencies,” he adds.
While the USD has been a safe haven currency historically, the recent upbeat risk sentiment among investors has also put the dollar in a weak position, says Tai.
“In the longer run, the USD is still vulnerable to depreciation since it is difficult to see the Fed unwind its loose monetary policy much earlier than other developed market central banks. Yet, in the near term, the USD could go through some consolidation since there are growing worries of another wave of infections in Europe and Asia. Investors’ risk appetite could weaken once more,” he adds.
What does a weak USD mean for the Asia Pacific market then?
“A weak USD typically is good for risk assets, particularly emerging market and Asian assets, both in fixed income and equities,” says Tai.
“That’s because a weak USD helps to reduce currency risks when investing in emerging markets and Asia, and allows EM Asia central banks to focus on delivering growth instead of keeping interest rates high to defend their currencies,” he adds.
Although strong Asian currencies may undermine exporters’ profit margin, it should be offset by a stronger demand worldwide.
“A stronger currency would help to reduce imported costs and potentially benefit companies serving domestic demand with imported components. In addition to the outlook of the USD, Asian equities’ valuations, as measured by price-to-book ratio, are in line with long-term average and consistent with constructive 12-month forward return,” he concludes.
