Core view:
Since 1973, the U.S. dollar has run a "two and a half" cycle. We believe that the U.S. dollar will enter a continued weakening trend in the future and complete the remaining half of the U.S. dollar downward cycle.
As early as March, we correctly predicted the current round of weakening of the US dollar. pointed out in "USD Liquidity Distress and RMB Exchange Rate Trends" on March 22 that the rapid strengthening of the US dollar at that time was caused by the "distress" of US dollar liquidity. Such an abnormal state will inevitably not last long, and the US dollar index of 103 is far away from the US economy. Fundamentally, the U.S. dollar index will fall back in the future, and the trend of the RMB will turn from weak to strong. In "Don't just see the strong Hong Kong dollar, but also see the spillover effects" on May 6, we emphasized this point of view again. In the "Current RMB Exchange Rate "Fight But Not Break"" on May 30, it was clearly stated that the baseline forecast for the U.S. dollar index in the next two quarters is to drop below 95, and the RMB against the U.S. dollar will return to a level of around 7.
Based on the above views, we try to answer three questions about the U.S. dollar index: First, what is the purpose of the China Merchants Macro team once again emphasizing the dollar's shift from strength to weakness? Second, to what extent will the dollar weaken? Third, what impact will the weakening of the U.S. dollar have on the allocation of major asset classes?
The following is the main text:
Q: What is the purpose of China Merchants Macro again emphasizing that the US dollar has turned from strong to weak?
Answer: As early as March, we correctly predicted the current round of US dollar weakness. We pointed out in the "U.S. Dollar Liquidity Distress and RMB Exchange Rate Trends" on March 22 that the strength of the U.S. dollar at that time was caused by the "distress" of U.S. dollar liquidity. Such an abnormal state will inevitably not last long, and the U.S. dollar index of 103 is far from 103. Based on the fundamentals of the U.S. economy, the U.S. dollar index will fall back in the future, and the trend of the RMB will turn from weak to strong. In "Don't just see the strong Hong Kong dollar, but also see the spillover effects" on May 6, we emphasized this point of view again. In the May 30 "RMB exchange rate is currently "fighting but not breaking"", we clearly stated that the baseline forecast for the U.S. dollar index in the next two quarters is to fall below 95, and the RMB against the U.S. dollar will return to a level of around 7.
At present, we once again emphasize that the US dollar index has turned from strong to weak, with three main purposes:
First, the EU has reached an agreement on the recovery fund, which may become an important driver of the weakening of the US dollar. EU leaders finally reached an agreement on a "recovery fund" totaling 750 billion euros, which means that the EU will begin to implement the largest economic rescue plan in history, of which 500 billion euros will be distributed in the form of direct grants to the economy that has been hit hard. Member states, the recipient countries do not need to repay, and the remaining 250 billion euros will be released as loans. The EU recovery fund means that Europe has made an important breakthrough in fiscal integration, a more united EU, and a more optimistic economic outlook in Europe, which will support the euro and push the dollar to weaken.
Secondly, the U.S. dollar has run a "two and a half" cycle since 1973, and some factors that have caused the U.S. dollar index to weaken after the COVID-19 epidemic are already brewing. Since the collapse of the Bretton Woods system in 1973 and the entry into the era of floating exchange rates, the U.S. dollar has experienced two complete cycles of strength and weakness (chart below). This round of strong US dollar began in 2012, and the acceleration phase began in July 2014, and has lasted for a long time. The macro background of the two rounds of trend weakening of the U.S. dollar index in history has the following commonalities: first, the Federal Reserve's relatively loose monetary policy, second, the deterioration of the U.S. current account balance (as a proportion of GDP), and third, the U.S. economic growth relative to the global Decline in GDP growth. Since the onset of the COVID-19 epidemic, the Federal Reserve has adopted a very loose monetary policy; the fermentation of the COVID-19 epidemic in the United States, especially the second fermentation, has extended the duration of the impact of the epidemic factors on the U.S. economy, and the probability of short-term impacts extending to the medium term is increasing, including in China. Some economies in China may have more optimistic economic fundamental prospects than the United States, and factors that contribute to the weakening of the U.S. dollar index are brewing.
Finally, as the U.S. dollar index fell below 95, more and more market voices began to be bearish on the U.S. dollar, indicating that the market consensus was increasing.On July 22, the U.S. dollar index fell below 95, falling to the lowest level since September 2018. This attracted market attention. More and more market voices began to be bearish on the U.S. dollar. The ICE U.S. dollar index non-commercial net position also reached fell to lower levels, indicating rising market power against the dollar. We also remind investors to pay attention to this change.
asked: How weak will the dollar be?
Answer: From 1985 to 1992, the U.S. dollar index fell 45%. Measured by monthly average, in July 1980, the U.S. dollar index began to bottom out from 84.6 and strengthened. The Federal Reserve entered an interest rate cutting cycle and rapidly cut interest rates in September 1984. In February and March 1985, the Federal Reserve The monthly peak reached 158.5 and 158.3, and then began to fall. The " Square Agreement " was signed in September 1985. At this time, the US dollar index had fallen by 12% compared with March 1985. After the Plaza Accord, the depreciation of the Japanese yen accelerated, and by the end of 1986 it continued to fall by 24%. The lowest point of this round of weakness in the US dollar index was 80.8 in August 1992, which was a 45% drop from the highest point.
From 2002 to 2008, the U.S. dollar index fell 39%. The U.S. dollar index reached a high of 119 in June and July 2001. After falling slightly, it rose again to 119 in February 2002. After forming a double top, the U.S. dollar index showed a trend decline. This contributed to the downward trend of the U.S. dollar index starting in March 2002. The lowest point of this round of U.S. dollar index decline was 72.1 in April 2008, which was a 39% drop from the highest point.
The U.S. Dollar Index may fall by 30% in the future, returning to levels around 70. The U.S. dollar index reached a high of 102 in December 2016, and then fell back but has remained at a strong level. Based on the historical depreciation of the U.S. dollar and the changes in each round of highs, we estimate the low point of this round of weakening of the U.S. dollar index. Probably around 70, but the process may take about 6 years.
asked: What impact does the weakening of the US dollar have on asset allocation?
Answer: Historically, the U.S. dollar index has a strong correlation with the prices of many assets. This correlation may not be a simple one-way causal relationship, because the strength of the U.S. dollar is not only the result of the macroeconomic environment, but also has significant spillover effects as an international currency. Therefore, other asset prices are both affected by the same macroeconomic environment and also have significant spillover effects. Affected by the strength of the US dollar index, this is the result of the interaction of multiple factors. But in any case, this correlation is a historical fact, so the judgment of the U.S. dollar index can also help us form judgments on the prices of other assets.
In our report "New Crown, the US Dollar and Major Asset Trends" on June 16, we proposed that if the US dollar weakens in a trend, it will have the following impact on asset prices:
First, the euro, Japanese yen, and emerging market currencies The exchange rate and the yuan will strengthen. If the U.S. dollar index weakens, the RMB exchange rate is expected to stabilize and rebound, and emerging market currencies are expected to escape the pressure. Among the currencies of developed countries, currencies with strong negative correlations such as the euro, Japanese yen, Canadian dollar, and Australian dollar also have the highest probability of appreciation.
Second, commodity prices stopped falling and rebounded. The US dollar index has a very significant negative correlation with various CRB indices except textiles and crude oil prices. The weakening of the US dollar index has led to a rebound in commodity prices.
Third, the weakening of the US dollar is conducive to the rise of gold prices. The correlation of gold prices is slightly lower than that of other commodities. The main reason may be that frequent risk events have had a significant impact on gold prices at many stages, and the US dollar and gold prices may rise at the same time. Therefore, a weaker U.S. dollar is conducive to rising gold prices, and the impact of other factors such as politics must also be considered.
Fourth, the weakening of the US dollar has led to an increase in Chinese government bond yields and a decrease in bond prices. The U.S. Dollar Index has a negative correlation with the yields on German Bunds, China Bonds, and Indian Treasury Bonds, which may mean that the downward phase of the U.S. Dollar Index may correspond to an increase in long-term interest rates in some countries.
Fifth, the U.S. dollar index has fallen, and the stock indexes of emerging economies will perform relatively better than the stock indexes of developed countries. has a view that the difference between MSCI developed and MSCI emerging moves in the same direction as the US dollar index.Based on this, we can infer that if the U.S. dollar index continues to fall in the future, the stock markets of emerging economies will perform relatively better than the stock markets of developed economies.
Investment macro team: Xie Yaxuan, Luo Yunfeng, Zhang Yiping, Liu Yaxin, Gao Ming, Zhang Qiuyu
