Dollar's Dominance Devastates BRICS Currencies

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Even after the US dollar rallied against all of its peers in the G10 this year, Goldman Sachs Research expects the greenback to largely retain its recent gains. Our analysts forecast the US currency to be essentially the same level in 12 months as the euro, the British pound, and Australia’s dollar.

Head of global foreign exchange, interest rates, and emerging markets strategy research, Kamakshya Trivedi, attributes much of this to the limited prospects for global macroeconomic divergence and the consistent growth of the US economy.

We discussed with Trivedi the team’s predictions, what could trigger a breakout of the US dollar from its recent trading range, and how the results of the US election in November might impact the currency.

What is the outlook for the US dollar for the next 12 months?

The US dollar has remained stable and within a narrow range for the first five months of this year. Looking ahead over the next 12 months, we anticipate several factors that will contribute to the ongoing strength of the US dollar. The primary reason for this is the robustness of the US economy. Despite high interest rates, the US economy is performing well and benefiting US stocks. Additionally, the expected rate cuts in the next 12 months are not likely to significantly reduce the yield on dollar bonds. While stronger growth or higher asset market returns in other parts of the world may potentially weaken the US dollar, there are also scenarios that could make the dollar even stronger than its current position.

Overall, we will continue to live in a world dominated by a strong US dollar, supported by various risk factors. Any decline in the dollar's strong valuation is expected to be gradual.

Is there anything on the horizon that could cause the dollar to swing sharply lower or higher?

It's important to note that significant changes in the value of the dollar are typically influenced by major differences in economic conditions, policies, or macroeconomic indicators. When conflicting reports on economic data occur, money tends to move from one asset market to another, such as from stocks to fixed-income securities.

In March and April, there were indications that we might see differences in the outlook for U.S. growth and inflation compared to Europe and China. However, things have balanced out since then. Over the past few months, the world has become more similar. Economic activity has slowed down a bit in the U.S. and improved in Europe, while China has shown better data with more urgency around policy adjustments to tackle its fundamental issues. Overall, we are witnessing more similarities, which has kept the dollar and other major currencies in a relatively narrow range.

Are there any countries in which that convergence hasn’t born out?

Yes, it’s important to consider that there are a few places in the world where we see significant differences. Japan is a prominent example. The real rate differential (the difference between inflation-adjusted interest rates) between the US and Japan is quite large. As a result, there has been a lot of attention on the trading and volatility of the dollar-yen exchange rate. However, even in this case, it seems that policymakers in Japan are not keen on allowing such divergence, and they have intervened to keep the dollar in check. Nonetheless, due to the difference in real rates, my colleagues expect the yen to remain weak for the months ahead. In China, policymakers also tightly manage the currency. Although there have been some positive economic data points recently, the long-term economic challenges compared to the US continue to pressure the currency.

Has the broad convergence dimmed interest in carry trade transactions?

Currently, there is significant interest in the carry trade. Due to the high US interest rates, it may not be the most favorable time to earn carry. However, in a scenario with limited policy variations and the dollar is trading in a narrow range with low FX volatility, some of our clients are keen on earning carry while waiting for larger trending moves. There are various options for earning carry, depending on an investor's risk appetite. Some are exploring higher-risk carry trades, such as those in Turkey or Egypt, while others are considering more conventional carry trade opportunities in countries like India or Mexico.

What about the Federal Reserve and interest rate policy?

The dollar could break out of its tight range if there are clearer signs of a macroeconomic divergence. For example, if the Bank of England and the European Central Bank cut rates later this year, but the Federal Reserve holds off and defers any cuts because its data set is less cooperative. This scenario could break the recent ranges and push the dollar even higher than it is now, as per our forecasts.

Are there other risk factors that could unwind the convergence and lead to swings in the dollar?

It's essential to consider the state of the US economy, as it seems to be performing well. Additionally, we should keep an eye on the upcoming US election as it could introduce potential risks such as increased fiscal spending or elevated tariffs on certain countries, including China. These factors can potentially influence the dollar's value and extend its recent fluctuation.

Recent history shows that the extent of fiscal expansion in the US election will likely depend on which party gains control of Congress, not just the outcome of the presidential race. If one party secures the presidency and control of Congress, they are more likely to pass extensive fiscal policies, potentially leading to a stronger dollar. In a scenario where the government is divided, passing significant fiscal measures becomes more challenging. In the upcoming election, there could be debates and potential implementation of trade policies and fiscal expansion measures. This may result in an even stronger dollar, which could pose a real risk for the rest of the world to manage.

What is the current status of the US Dollar in relation to the BRICS nations? Is it merely surviving or is the US Dollar thriving? Let’s jump in.

US Dollar Shows No Mercy To BRICS Nations’ Currencies

The US dollar is significantly impacting BRICS and their de-dollarization agenda, as it caused major drops in the value of leading BRICS currencies in July 2024. The Chinese yuan, Indian rupee, and even Asia’s top currency, the Japanese yen, are facing challenges in competing with the dominance of the US dollar.

The BRICS' de-dollarization efforts have not been effective in reducing the US dollar's influence. Instead, the US dollar continues to significantly impact the currencies of BRICS nations in the foreign exchange market. At the close of trading last Friday, the Indian rupee, a member of BRICS, reached a new all-time low of 83.73 against the USD.

China, which spearheaded the BRICS de-dollarization campaign, is seeing the yuan fall to a seven-month low against the US dollar. The Japanese yen is at its lowest point in 34 years, struggling to gain strength in the forex markets. This situation makes the US dollar dominant, with other local currencies trailing behind.

The rise in US Treasury yields has strengthened the dollar against other major currencies in the market. The DXY index, which measures the USD's performance, indicates that the currency is securely above the 104.30 mark. While the USD maintains its momentum, the same cannot be said for the currencies of BRICS nations.

The strength of the US dollar is causing BRICS currencies to decline despite efforts to challenge its reserve status. Furthermore, currency investors buying the US dollar during downturns have strengthened its resistance level, leading to a more vigorous rebound.

“The markets got a little overextended, and firmer yields have helped the dollar,” said Shaun Osborne, Chief foreign exchange strategist at Scotiabank. Now that Biden’s presidency is coming to an end, the US dollar’s prospects will be decided by the next president.

That’s it for this episode!

Stay informed. Stay vigilant. Stay ahead.

The Modern Warfare Team

Disclaimer: This newsletter is for informational purposes only and should not be construed as financial or political advice.

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