It has been a volatile year for the US dollar, which has given back nearly all of its gains in 2020 after behaving as a “safe haven” during the market volatility in March. While a variety of factors and headlines can have short-term effects on the dollar, an important longer-term driver is the US “twin deficits”—the combination of the budget deficit and the trade deficit.
As a historical net importer, the US has usually carried a trade deficit, and with the passage of the record setting CARES Act—the first trillion dollar stimulus package—the budget deficit has ballooned and has stretched the sum of the two deficits to historically low levels as a percent of gross domestic product (GDP). As seen in the LPL Chart of the Day, changes in the twin deficits has usually been a relatively accurate predictor of the long-term trend in the value of the US dollar:
Following such an extreme expansion in the twin deficits, we continue to be negative on the dollar. While the dollar’s status as the world’s reserve currency provides a buffer against extreme short-term moves, the backdrop of record fiscal and monetary stimulus should continue to keep downward pressure on the greenback.
“The recent bout of US dollar weakness lines up with the start of better relative performance for international stocks,” said LPL Financial Chief Investment Officer Burt White. “After many years of US leadership, a potential sustained turnaround would be a welcome positive for globally diversified US investors.” Despite moderate improvement in economic data as the US economy slowly emerges from lockdowns, we expect policymakers to continue to keep the stimulus faucet running as long as needed—keeping a lid on any short-term strengthening in the dollar.
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Dollar Index – A measure of the value of the U.S. dollar relative to majority of its most significant trading partners. This index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.
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