Dollar rides high on stimulus tsunami

The dollar drought has turned into a flood, as the Fed has cut interest rates to almost zero and pumped $2 trillion into world markets. But what if this immense stimulus wave is responsible for supporting rather than weakening the greenback?

An index measuring the dollar’s value against a basket of six currencies has eased 3% since mid-March but is still on track for a fourth straight month of gains. And a trade-weighted index remains at three-year highs in a Fed index.

Essentially, markets have shrugged off a surge in dollar supply from the Fed, rising US public debt, the economic hit from the pandemic and, above all, shrinking yield premiums over other currencies — 10-year US debt now pays 1% over the euro equivalent, for instance, half the spread prevailing in February.

Despite the vanishing yield premiums, the dollar index soared 8.5% in under three weeks during March — the biggest rise in such a short interval since 2008 — as investors stampeded for the world’s safest and most widely used currency.

But markets have since calmed and dollars are no longer scarce, based on pricing in cross-currency swap markets.

Many see this resilience as temporary, but the very size of the Fed’s stimulus could be a source of strength for the dollar.

Since February, the balance sheets of the 10 biggest central banks has expanded by $3.7 trillion, roughly equal to the sum of their assets before the 2008 crisis, Deutsche Bank estimates. The Fed accounted for half that increase, increasing its balance sheet by half, but far from weakening the dollar, it did the opposite.

“The Fed appears to be working under the premise that in past crises of historic proportion, there are almost no occasions when monetary authorities are ... accused of doing too much,” said Alan Ruskin, chief international strategist at Deutsche Bank.

He said stimulus elsewhere has often been viewed as a sign of weakness or, at worst, pulling the same policy levers multiple times.

Notably, between June 2014 and March 2015, the ECB expanded its balance sheet to 25% of GDP. In response, the euro sank 25%.

Deploying big policy action seems to yield different results in the United States, where demographic and labour-force strengths can drive a swift rebound in credit demand.

That leads markets to look ahead to recovery, rather than worry about the immediate effects on the currency.