Listen to On the Minds of Investors
2020 ended with a depreciation of the U.S. dollar, down 8% from its intra-year high in April and down 3% for the year (measured by the real effective exchange rate). As 2021 begins, investors wonder: will the U.S. dollar continue to fall?
Historically, the U.S. dollar goes through long cycles of strength and weakness, correlated with the difference between U.S. and international growth. The wider the international growth alpha, the stronger the pull is away from U.S. markets, as investors search for income and growth globally. In contrast, the smaller the international growth alpha, the stronger the pull is into U.S. markets, as investors search for income, growth and safety in U.S. assets. While the dollar did depreciate during the last eight months of 2020, this came on the heels of eight years of dollar strength. This was a period characterized by a small international growth alpha of 0.5% points, a significant step down from the 1.2% points seen from 2001 to 2011 when the U.S. dollar weakened.
This shrinking gap resulted from a shift up in U.S. growth that did not occur internationally due to Europe and emerging markets excluding China. The European Union went from contributing 22% to global growth from 2001 to 2011 (in nominal U.S. dollar terms) to subtracting 4% from 2012 to 2019 due primarily to the sovereign debt crisis. In turn, emerging markets, excluding China, went from contributing 17% to global growth from 2001 to 2011 to 12% from 2012 to 2019. In particular, Latin America and EMEA detracted from global growth as a result of the bursting of the commodity bubble and the credit deleveraging cycle. A synchronized global recovery started to take hold in 2017, but was quickly disrupted by the trade war.
Going forward, the cycle seems to be turning. From 2021 to 2025, the international growth alpha should widen back to 1.2% points as international growth shifts up, resulting in a weaker U.S. dollar. Initially, this will be due to the emergence of the global economy from the pandemic; however, longer term, it is about detracting regions becoming contributors once again. The European Union should contribute 17% to global growth, as the fiscal union forged during COVID-19 pays dividends long after. In addition, emerging markets, excluding China, should increase their contribution to global growth to 25%, as Latin America and EMEA become small contributors to growth post their painful adjustments. China’s growth should remain strong propelled by its growing middle class, contributing a hefty 28% to global growth, by far the highest contribution of any country. Lastly, the expected decrease in trade uncertainty under a Biden administration should ensure a more lasting pick up in international growth this time.
This expected cycle of U.S. dollar weakness would benefit U.S.-based investors investing internationally through currency translation. In addition, a weaker dollar environment is particularly beneficial for emerging market assets.
A wider international growth alpha should lead to a weaker U.S. dollar
Real GDP growth: U.S.-intl. (5-year moving avg.); U.S. dollar: 100 = 1984