What could push the U.S. dollar lower?

Structural factors in the U.S. will likely persist, and absent offsetting capital inflows, the greenback is likely to face downward pressure.

The U.S. dollar has softened since hitting its two-decade peak in September 2022 with the greenback now at levels seen at the start of the year as of mid-November. In the long run, however, there are structural and cyclical factors that could support a weaker U.S. dollar.

Structural factors such as the twin deficits—budget and current account deficits—in the U.S. will likely persist, and absent offsetting capital inflows, the greenback is likely to face downward pressure. Moreover, the issues around government spending and elevated debt and deficit levels bode negatively for the U.S. dollar. There is also some risk of prolonged political brinkmanship with a divided and partisan U.S. government. Absent a resolution, a risk premium might be warranted in the valuation of the U.S. dollar.

There are cyclical factors that may guide the U.S. dollar in the long run. The U.S. exceptionalism narrative has arguably underscored the markets’ bullish views on the greenback in recent quarters. While U.S. growth momentum is expected to ease next year, a sharper deceleration in the U.S. economy could trigger an earlier-than-expected monetary policy easing cycle by the Fed. This may imply a narrowing of the U.S.-developed market (DM) government bond yield differential that could exert downward pressure on the dollar. Looking ahead, a weaker U.S. dollar may provide opportunities to rotate toward emerging market (EM) equities.

Exhibit 11:

Source: FactSet, OECD, Tullett Prebon, WM/Reuters, J.P. Morgan Asset Management. *The U.S. dollar index shown here is a nominal trade-weighted index of major trading partners’ currencies. Major currencies are the British pound, Canadian dollar, euro, Japanese yen, Swedish kroner and Swiss franc. **DM is developed markets and the yield is calculated as a GDP-weighted average of the 10-year government bond yields of Australia, Canada, France, Germany, Italy, Japan, Switzerland and the UK. Past performance is not a reliable indicator of current and future results.
Guide to the Markets – Asia. Data reflect most recently available as of 30/09/23. 


That said, the road toward a weaker U.S. dollar could be bumpy. Several factors could reaffirm the risk-off scenario, hence extending the resilience of the greenback in the coming months.

First, the recent surge in long-end UST yields, widening in the U.S.-DM government bond yield differential, could persist on account of the expanding U.S. federal budget deficit, which implies an increase in UST issuance next year. This means long-end UST yields could still grind higher, elevating the fair value of the U.S. dollar.

Second, demand for safe-haven assets such as the U.S. dollar tends to rise with volatility, such as periods of heightened geopolitical tensions, which may warrant a premium in the U.S. dollar. These factors lend credence to the bullish U.S. dollar view in the near term.