When crisis strikes, US dollar is king

Via Michael Every at RaboBank:

There are lots of theories about what factors drives FX markets: interest rate differentials; real interest rate differentials; central bank actions like QE; real effective exchange rates; ‘fair value’; the fiscal deficit; the current account deficit; capital flows; speculation; sentiment; and technicals. (Add your own if I missed one.) Of course, none of these factors alone ever tells you where a currency is actually going to trade on any given day, and the precise combination of the above that might shifts all the time from currency to currency (almost as if they aren’t actually explanatory at all…)

Think of the USD. Can you think of a currency less deserving of its current strength? True, rates are at 2.50%, but the market is now expecting two cuts this year, and our Fed watcher Philip Marey is talking about five cuts once the Fed gets moving. Think about the vast and rising US fiscal deficit and public-sector debt, and then about the sizeable trade and current-account deficits it always runs. Consider the trade war, which should–in the eyes of some–be choking off capital inflows that hold the USD up. Yet a strong USD, especially vs. EM, continues to be seen this year, as we had expected, and as we continue to expect. That’s true even if we broaden our range of indicators out to consider that US hegemony and USD reserve status perhaps aren’t what they used to be, with ever-more speculation that the day of the Dollar is over.

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