Expect the weak dollar trend to return

It was meant to be the no-brainer trade of 2021: Keep selling the dollar on a big-spending Joe Biden presidency. The money-printing required to fund US stimulus would heap pressure on the greenback, reinforcing a market dynamic at work since March. Now the Democrat 'blue wave' has happened, why has the dollar actually rebounded slightly?

Countertrend rally

The shock storming of the Capitol on Jan. 6 turned the greenback on a dime: The dollar acts a safe haven during periods of turbulence, even when they are happening in the US. That said, equities have remained strong and have touched fresh highs undeterred by politics. The bigger yield premium for US bonds versus foreign debt may also be creating demand for dollars from overseas buyers, notably Japanese funds.

Mixed messages from the US Federal Reserve have also clearly played a role. Short positions in the dollar were likely squeezed when several members of its Federal Open Market Committee recently turned optimistic on a post-pandemic economic recovery. That stance might lead them to vote for reducing planned quantitative easing later this year, something of a mood shift from the December FOMC meeting. A slowdown in Fed money-printing would support the dollar.

The modified position caused a mini-repeat of the 2013 'taper tantrum' triggered by then-Fed Chair Ben Bernanke signalling a gradual withdrawal of QE. But it is worth listening more to the top leadership of the Fed here. Vice Chair Richard Clarida recently said he saw no change to the $120 billion per month of QE outlined for this year. And on Thursday, Chair Jerome Powell sounded a familiarly dovish tone in the way in which he discussed the timing of any future reining in of asset purchases.

Breaking out

The reality is that greater fiscal spending is coming, requiring commensurately higher government bond sales to fund it. The market will have to consume an unprecedented $1.8 trillion of Treasury debt in 2021, according to analysts at JP Morgan Chase & Co. The Fed's money-printer is going to be whirring away to help with digestion.

Meanwhile, investors are increasingly alert to the impact of rising bond yields, reflecting a buyers' market for the glut of US Treasury issuance, and the expectation that stimulus could drive inflationary pressure. The Fed has seemed relaxed about this so far. That could change if higher yields spook the stock market, prompting moves to defend financial stability, the obvious tool being more QE.

Once the Biden administration settles in, and assuming normality of a sort resumes, then there are enough reasons to believe the prevailing downward dollar trend will reassert itself. There are going to be a lot more dollars around - and that tends to erode the greenback's value. (Bloomberg)