EC Dollar View: Discipline Or Stubbornness?

The US dollar is sitting near multi-month lows against the major European currencies and the dollar bloc. Where does this leave our strategic view of the third significant dollar rally since the collapse of Bretton Woods?

The dollar bear market ended in 2007-2008 when extremes were made, with the euro trading above $1.60 (2008), and Sterling above $2.11 (2007). The US dollar fell to nearly CAD0.90. The yen is a notable exception. It did not put it a top until 2011. That is also when the real broad trade weighted dollar bottomed as well.  

We anticipated a secular dollar recovery. My book, Making Sense of the Dollar (Bloomberg, 2009) argued against many of the “myths” that were used to justify and explain the dollar’s decade-long decline, like it was losing it reserve status, or that is chronic current account deficit was undermining its reserve status, or that the Chinese yuan was going to replace the greenback.  

The first dollar rally after the demise of the Bretton Woods system was fueled by the tightening of monetary policy under Volcker and the expansionary fiscal policy associated with Reagan. After intervention (Plaza Agreement, 1985) had arrested the dollar’s rally, it entered the decade-long bear market. 

The second dollar rally was associated with the tech bubble in the second half of the 1990s. The groundwork was the Fed tightening in 1994 and the abandonment of the occasional practice of US Treasury Secretaries (like Baker and Bensten) of using the dollar as a weapon to force concessions from US allies. In October 2000, at the behest of the ECB, there was coordinated intervention to stop the newly-born euro from falling further. This meant capping the dollar. It went through another multi-year bear market.  

Early on, we identified the divergence of monetary policy, broadly understood, as the driver of the third dollar rally. While the dollar bear market may have ended in 2007-2008, the bull market arguably did not begin until the middle of 2014, and the Fed’s first hike was not delivered until the end of 2015.