What's going on?
The dollar chalked up its best performance in three years last quarter – much to the surprise of skeptical analysts and contrarian investors alike.
What does this mean?
The dollar’s safe-haven status saw the currency become an investing go-to during last spring’s coronavirus-induced meltdown, and its value shot up accordingly. But with economic growth on the rise and market volatility on the decline over the past six months, plenty of investors came into 2021 betting that the dollar would give up those gains – and then some.
Instead, a popular index tracking the dollar’s value versus six other major currencies jumped 3.6% last quarter. That could be because investors increasingly expect the US economy to outperform its rivals, thanks to a successful vaccination campaign and a $1.9 trillion infrastructure proposal. Alternatively, it could be because US government bond yields have risen lately, making dollar-denominated bonds look a lot more attractive than other countries’ debt.
Why should I care?
For markets: When in doubt, invest in the dollar.
The dollar’s recent performance calls to mind the so-called “dollar smile theory”. That is, when the US economy is expanding relatively rapidly compared to the rest of the world, overseas investors tend to buy American investments – priced in dollars – in hopes of getting in on the action. The smiles keep coming when the world’s in crisis too, which is when the dollar looks like a particularly safe bet…
The bigger picture: If you’re invested in the dollar, have your doubts.
Investment banks might be backtracking on their predictions of a weaker dollar in the near future, but they’re sticking with them in the long run. A widening trade deficit means the US is buying more goods overseas than it exports, which means it has to sell the dollar to buy overseas currencies. A widening budget deficit, meanwhile, suggests the US government’s spending is exceeding its revenue – making its debt riskier and, in turn, less appealing.