U.S. Dollar Depreciation Continues

  • In the past few years, with the European Central Bank’s negative interest rate policy, the euro has become more and more popular with carrying traders
  • After the Fed cut interest rates to zero this year, the attractiveness of investors to hold dollar-denominated assets is decreasing.
  • The continued weakness of the US dollar this year is another reason for the popularity of carrying trades.

This year, the continued depreciation of the U.S. dollar, and the Federal Reserve’s holding of interest rates at a low level, have allowed investors to restart the U.S. dollar carry trade that has been suspended for many years. That is, to borrow U.S. dollars to purchase riskier assets.

US Dollars

Cargo trading refers to the trading behavior of borrowing funds from the low-interest market and then investing in high-return assets such as currencies, stocks, and other asset markets to earn interest margins and capital gains.

A currency suitable for carrying trade usually needs the support of its low domestic interest rate environment and is in a stable and depreciating state.

In the past few years, with the European Central Bank’s negative interest rate policy, the euro has become more and more popular with carrying traders, because negative interest rates mean that investors can still get income by borrowing money.

Correspondingly, during the Fed’s interest rate hike from 2015 to 2017, the attractiveness of the U.S. dollar as a financing currency continued to decline. But this year, as the interest rate differential between the Eurozone and the United States narrowed, the situation reversed.

After the Fed cut interest rates to zero this year, the attractiveness of investors to hold dollar-denominated assets is decreasing. Given the Fed’s commitment to keeping US interest rates near zero for the foreseeable future, this situation may continue for some time.

The Federal Reserve’s debt purchase measures, namely the purchase of corporate bonds and treasury bonds, also caused bond yields to plummet.

In the eyes of investors, when the inflation rate is expected to rise, the actual yield of holding U.S. Treasury bonds has fallen to a negative value, thus losing its appeal as a safe-haven asset. Based on this, investors seeking higher yields are now turning to bonds outside the United States, which provide positive yields adjusted for inflation.

Jan Dehn, head of research at the investment company Ashmore Group, said that recently in his portfolio, he sold US dollars to buy local currency government bonds in Mexico, Indonesia, and Brazil.

US Dollar Index

The continued weakness of the US dollar this year is another reason for the popularity of carrying trades.

According to data collected by RBC Capital Markets, the speculative bet on the currency of the Group of Ten (G10) countries will appreciate against the US dollar is currently at a two-year high. The US dollar index has fallen by about 2.3% so far this year, perhaps its worst performance in three years.

Dehn expects the dollar to weaken in the next few years, because economic recovery outside the United States may be faster than the United States.

Vasileios Gkionakis, head of foreign exchange strategy at the Swiss private bank Lombard Odier, also believes that the US dollar is still overvalued by 10% to 15%, and bet that the US dollar will fall further in 2021. He plans to use the U.S. dollar as a financing currency to bet on the strengthening of Asian emerging market currencies including the renminbi and the Korean currency.

Stuart Edwards, Invesco’s UK fund manager, also expects the dollar to weaken, especially given the recent interest rate guidance given by the Federal Reserve. “It is very difficult to bet against the Fed.”

He said that he had bought Mexico’s local currency government bonds with U.S. dollars. Goldman Sachs recently stated that the Mexican peso has risen by 13.1% from its March low and is expected to provide a return of approximately 2.25% in 2021.

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Benedict Kasigara

I have been working as a freelance editor/writer since 2006. My specialist subject is film and television having worked for over 10 years from 2005 during which time I was the editor of the BFI Film and Television.

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