Four factors suggest a continued downtrend in the dollar: a still-expensive starting point versus fair value, improving growth momentum overseas, shrinking interest rate differentials versus the rest of the world and flows returning to non-U.S. markets.
As 2022 ended, the global economy was losing speed, with only 32% of countries registering a manufacturing PMI over 50 (signaling accelerating momentum). The question for 2023 was how much further momentum would fall: a recession in Europe was a foregone conclusion due to the energy price shock and a slow China recovery was expected due to a slow unwind of the “Zero COVID policy” (ZCP) shock. Today, instead of slowing down, the global economy has picked up speed, with 40% of countries registering a manufacturing PMI over 50 and the global services PMI at an 18-month high.
What changed? Last year’s two big negative shocks have turned positive. In the eurozone, the consensus recession was very shallow. Surging energy prices turned into plummeting energy prices, with European natural gas prices 55% below levels before the war in Ukraine. Manufacturing is now stabilizing, and services are seeing a boost from consumption as headline inflation falls rapidly (10.6% in October to 6.1% in May). Looking ahead, the eurozone’s April composite PMI of 52.8 in May suggests growth closer to 2%. Record low unemployment and rising wages provide a cushion to the lagged impact of 375 basis points of tightening by the European Central Bank (ECB). In China, the elimination of ZCP occurred rapidly, and the reopening impulse is powerful. This is a unique Chinese recovery: focused on the consumption rebound of 15% of the world’s population after three years of below-average spending. Travel and leisure spending has bounced back strongly – now the question is whether other services and goods spending will pick up as well. A recovery in private business and consumer confidence is key. If not, Chinese policymakers have room for more stimulus with headline inflation at only 0.1% in April. China’s recovery is a powerful tailwind to its major trading partners (and tourist destinations) in Europe and Asia. As a result, a divergent global economic path seems likely with the U.S. slowing and the eurozone, China and broader Asia accelerating (Exhibit 1).
A key place to look for this impact is the U.S. dollar, which has weakened 9% since late September; however, this follows an 11-year cycle of appreciation (Exhibit 2). Four factors suggest a continued downtrend in the dollar: a still-expensive starting point versus fair value, improving growth momentum overseas, shrinking interest rate differentials versus the rest of the world and flows returning to non-U.S. markets. This should provide a relief for central bankers’ fights against inflation and for U.S. dollar-based investors’ international returns.