The president, the stimulus, and the dollar
Real Estate | London
With Joe Biden’s feet firmly under the Resolute desk in the Oval office, and having just signed one of the largest stimulus packages in U.S. history, it seemed appropriate to look at the impact on the USD and financial markets in general.
In the lead up to every election, there are inevitable questions from investors of what each candidate’s policies will mean for the economy, the stock market, and the U.S. dollar.
Though American presidents have limited direct control over the direction of the USD, their words and policy actions have significant influence. The USD declined by 12% during Trump’s first year in office. Treasury Secretary Steven Mnuchin’s championing of a weaker U.S. currency also contributed to some of the decline. However, it would be inaccurate to suggest that Donald Trump being president caused the dollar to weaken. In fact, it had strengthened significantly upon his election and recovered almost all the losses prior to the coronavirus pandemic last year.
Upon Biden’s election, and subsequent victory in the Senate that gave the Democrats control of both houses of Congress, many currency forecasters were predicting that the dollar would weaken by as much as 10% this year. So far in 2021, the dollar index has strengthened by 2%. Comparing movements in long-term interest rates can help explain some of the differences in the dollar’s fortunes.
Since the start of the year, there has been a large move up in long-term interest rates. The benchmark 10-year U.S. Treasury yield has risen by ~60 basis points (bps) to 1.70%. This compares with a rise of just 8 bps in the same period of 2017. Looking at a specific currency’s 10-year yield spread in the table below, we can get some idea of the impact of yield on its value vs the U.S. dollar.
Sentiment is another key contributor to whether the U.S. dollar, as the world’s de facto reserve currency, strengthens or weakens. Periods of relatively stable global growth and favourable fiscal policies, such as Trump’s vast proposed tax cuts in 2017, allow for heightened risk tolerance, pushing money into riskier, higher yielding assets typically outside of the U.S. which can cause the dollar to weaken. But in periods of elevated global fear, or market stress such as in March 2020, risk aversion takes hold, pushing assets into relative “safe havens” like U.S. Treasuries and the U.S. dollar, causing it to strengthen and even leading to temporary market distortion.
One might expect deteriorating sentiment, and thus a weakening dollar, due to the concern that the $1.9 trillion stimulus package will overstimulate the U.S. economy and drive inflation higher, causing the Federal Reserve to tighten monetary policy much earlier than it is communicating. However, the risk of earlier policy normalisation by the Federal Reserve appears to be having a greater influence on investor behaviour evidenced by a strengthening dollar as of late.
Some Fed officials have mentioned tapering the central bank's asset purchases. But Chairman Jerome Powell quickly rebuffed concerns of premature tightening and has repeated such reassurances on several occasions. The mixed communication has raised concerns and prompted some of the largest one-day moves in U.S. Treasury yields in recent weeks.
The relative attractiveness of U.S. financial assets is starting to increase again, following the Fed’s significant monetary policy action just over a year ago. Interest rate differentials, especially currencies whose economies are beset with disinflationary problems (such as the Eurozone and Japan) are widening.
No matter who is president, they all face the same dichotomy; on the one hand, a stronger dollar is a signal of market confidence in the United States and that’s attractive, while on the other, a stronger dollar also acts as a headwind for trade.
In summary, there are many different influences on currency movement. This year has had a particularly volatile start with sentiment around vaccine success and the lifting of lockdown restrictions impacting short-term movements. Making sure you have the appropriate understanding of FX risks faced and the strategies to mitigate them will be critical to ensuring the key financial metrics are exceeded or achieved.
Chatham can help you with your FX strategy
Contact us to learn more
* Since no commonly issued bond exists for the eurozone, German Bunds are considered the benchmark for the euro area and are used in this comparison.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.21-0087
Our featured insights
BoE holds rates steady again while ECB pauses record run of hikes
The Bank of England (BoE) kept rates on hold at 5.25% for a second consecutive meeting today, as it attempts to balance a weakening economy with inflation that is still measuring three times its target. The Bank's updated forecasts show medium-term inflation slightly higher than in August's...
Jackie Bowie discusses the Bank of England's interest rate decision on Sky News
Business Live host Ian King interviews Jackie Bowie about the Bank of England's November interest rate decision. Will the decision follow the consensus of pausing the interest rate hike, or will the Bank continue rising?
Jackie Bowie reviews the 10-year Treasury and interest rates on Bloomberg Daybreak Europe
Bloomberg Daybreak Europe interviews Jackie Bowie about the Bank of England's November interest rate decision. With the U.S. refunding announcement in focus alongside a headwind of geopolitical risk, there have been negative views impacting sentiment as more people are paying attention.
CAD/USD volatility continues as Canadian and U.S. monetary policy diverges
CAD and USD have been among the most volatile global currency pairs in recent weeks.
Market update as regulators take control of troubled banks
Since Friday, March 10, we’ve observed the distress of two banks, Silicon Valley Bank and Signature Bank, which have both been placed into FDIC receivership. The FDIC has taken the step of guaranteeing the deposits of both banks above the legislated $250K per account limit, and the Federal Reserve has demonstrated further commitment to ensuring bank liquidity by establishing the Bank Term Funding Program.
The ECB holds firm while the BoE wavers
On 15 December, the European Central Bank (ECB) voted for a further 0.5% interest rate increase as the central bank continues its policy of monetary tightening in the face of high inflation. The bank slightly slowed the pace of increases (from 0.75% previously) as signs of a softening inflation...
The first 75 bps hike from the Bank of England in 33-years in a split vote
On 3 November, the Bank of England (BoE) voted seven-to-two to raise the U.K. base rate by 0.75% to 3.00%, the two dissenters voting instead for hikes of 0.25% and 0.50%. The BoE Governor, Andrew Bailey, voted for the 0.75% hike while pointing to a slowdown in the pace of future hikes. This move...
Inflation persists despite historically fast hikes
On Wednesday, November 2, the Federal Open Market Committee (FOMC) voted unanimously to raise the federal funds target range by 75 basis points to 3.75–4.00%. This rate hike is guided by their long-term dual mandate of price stability and simultaneously ensuring maximum employment. The Fed is...