COLUMN-Twin deficits may conspire to curb the galloping dollar: McGeever
Band Jamie McGeever
ORLANDO, Fla., November 23 (Reuters) – Remember when twin deficits were a thing for the dollar?
It has been a long time since dollar watchers had the U.S. current account and fiscal spreads on their radar, but that could change next year, especially if the global economy heats up and the U.S. economy continues to shrink. outperform its peers.
The United States’ balance of payments position vis-à-vis the rest of the world is deteriorating. In the three months to June, it was in the red at $ 190 billion, or 3.4% of gross domestic product.
This may only be about half of the record deficits of over 6% in 2005 and 2006, but it is still the largest US current account imbalance since 2007. The deficit has exceeded 3% of GDP. for five consecutive quarters.
According to the non-partisan Congressional Budget Office, the federal budget deficit is expected to exceed $ 1 trillion next year, or at least 4.7 percent of GDP, down substantially from the record 14.9 percent of GDP on last year and forecast 13.4% this year.
This shrinkage is enormous. But then again, it’s still historically important, and with the current account deficit it will take huge amounts of dollars to flow into the United States just to keep the currency from weakening.
It comes as the Federal Reserve is about to unwind its $ 120 billion monthly purchases of US Treasuries and mortgage-backed securities. By the middle of next year, he will have stopped buying bonds, except for reinvestments.
Of course, deficits will not be the main driver of the dollar next year. It will be the widening of the interest rate differential in its favor as the Fed prepares to hike rates, while other central banks – notably the ECB and BOJ – keep their powder dry.
There are two other important reasons why structural problems are unlikely to suddenly torpedo the dollar.
One is American “exceptionalism” – the reserve status of the dollar, the position of Treasuries as a global benchmark for interest rates, and Wall Street’s role as a world market leader. The US current account deficit is unlike any other current account deficit.
Second, “fair value” models for exchange rates in which balance of payments flows are strongly taken into account may work in the long run, but are less reliable over shorter time periods.
But dollar bulls would be wise not to indulge in the double deficit issue.
“You can be assured that this will be the first port of call if the dollar begins to weaken steadily,” said Deutsche Bank strategist Alan Ruskin.
He suggests that a current account deficit of 4% or more of GDP is a warning sign for the dollar, and that a larger currency decline would follow in the unlikely event that it reaches 5% or more.
AN OVERVALUE DOLLAR?
The dollar pays no attention to the growing imbalance. Backed by the Fed preparing for an interest rate take-off in 2022, it is up 7% so far this year against a basket of major currencies, on course for its biggest hike in six years .
But Goldman Sachs analysts argue that the large US current account deficit means the dollar is overvalued by up to 13%. They calculate that a deficit of around 2.5% of GDP is a sustainable norm, so the current level is a headwind for the dollar.
“If the current account deficit remains large even as fiscal stimulus fades, the weak dollar may eventually be needed to achieve external balance,” they write, forecasting an average deficit next year of 3 , 2% of GDP.
Where will the influx come from? Wall Street’s relentless rally this year has drawn global demand for US stocks, creating a virtuous cycle of rising asset prices and inflows.
The S&P 500 is up 25% year-to-date and could set a new record for new all-time highs in any calendar year. Alex Etra from Exante Data calculates that funding for the current account deficit is increasingly coming from European equity investors instead of overseas reserve managers.
If the imbalances continue to grow, the pressure on the dollar is sure to intensify, he warns.
But Daragh Maher, head of research for the Americas at HSBC, retorts that twin US deficits have been a constant feature over the past 50 years and that the dominant narrative for the dollar has been either risk appetite or rates. relative.
“Right now it’s the relative rates, and the structural story is that the story is secondary at best,” he notes.
US current account against dollar https://tmsnrt.rs/3nEAZMO
Global imbalances are widening again https://tmsnrt.rs/3cAZNiD
(Written by Jamie McGeever, Editing by Alison Williams)
((firstname.lastname@example.org; +1 (407) 288-5607; Reuters messaging: email@example.com))
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.