Almost nothing can dislodge the dollar

LONDON: The dollar was trading at a 29-month high against a basket of rival currencies last week, while pummelling the euro to its weakest since May 2017.

While the US currency has been in favour for several years, thanks to relatively high US interest rates and a strong economy, the ongoing trade war with China and a scramble for funding in US money markets has added fuel to the fire.

The dollar’s outperformance is particularly broad, with an index compiled by Commerzbank showing that measured against a group of rival currencies it has risen 3.5% since July 1.

The euro has not declined as much. It has held up well against a weakening yuan — China is one of the euro zone’s biggest trading partners — but the sheer size of the dollar’s rally has left the single currency down 0.5% over a similar period.

The dollar has gained almost regardless of what has happened with trade talks. Even when they broke down, investors piled into the dollar seeking a safe haven thanks to its deep liquid markets.

Yet when a truce in the trade war has seemed within reach, traders have also bought the greenback, anticipating an economic boost from any kind of agreement.

The relative outperformance of the US economy has been a significant driver for dollar strength, but signs of a deepening downturn in the euro zone have played a major role recently.

The gap between the euro zone and the US on a Citigroup “economic surprise” index has risen sharply. Europe is now underperforming by a bigger margin than at any time since late 2017.

Turmoil last month in the US repurchase market for shortterm funding may also explain why dollars are so in demand.

Interest rates in the $2.2-trillion market for repo agreements rose as high as 10% on Sept 17 as demand for overnight cash from companies, banks and others exceeded supply.

While the jury is out on the significance of the spike, concerns about a shortage of short-dated dollar-denominated funding have increased.

Finally, there is the relatively high yield investors earn on US government bonds versus those in the euro zone.

While the Federal Reserve has launched a rate-cutting cycle this year, so has the European Central Bank, and expectations are that US rates will remain far higher than those in other developed markets for the foreseeable future.