Why is the dollar so low?

In the United States (US), the sixth rate hike since the end of 2015 will be implemented next week. However, the dollar is not shrinking. This has everything to do with the way in which the policy of US President Donald Trump undermines the value of the US currency.

Mario Draghi, president of the European Central Bank (ECB), has heightened tensions ahead of the release of the eurozone's final inflation data (Friday, March 16). Draghi said on Wednesday 14 March that the ECB is likely to continue to buy of bonds and assets, as long as inflation does not approach 2%.

That comment indicates that the probability of an interest rate hike before the end of this year has become much smaller; smaller than what it looked like at the turn of the year. That is a big difference with the US. As it looks now, interest rates in that country will be even higher in 1 week than they are now.

90% chance of higher interest
The Federal Reserve (Fed) will make a decision on Wednesday, March 21. According to economists, there is a 90% chance that the bank will then implement the sixth rate hike within 2,5 years. As far as inflation developments are concerned, the light is in any case in the green. On Wednesday, March 14, it was announced that the price level in the US was 2,8% higher last month than 1 year earlier. Only a very moderate wage increase could cause the Fed to postpone the rate hike.

On Friday, March 9, it emerged that the number of jobs in the US is growing and that unemployment (4,1%) remains very low. However, the average hourly wage was only 0,1% higher than in the previous month. Higher salaries are usually an important ingredient for rising spending, which in turn leads to rising inflation. Even if the Fed chooses to wait a little longer, the central bank will remain on track (3 rate hikes before the end of 2018). As a result, the difference with the European interest rate will probably rise to 2,5%.

Interest rate gap widening
The growing interest rate gap makes it more attractive for savers to hold capital in a US account. A similar pattern is unfolding in the bond market. In the US, the yield on government bonds with maturities has risen to 2,8%. That is 2 percentage points more than for German government bonds. Despite the large and growing interest rate differential, the dollar has only lost ground (against the euro) since early 2017.

This is partly due to the strength of the euro, which has been given a tailwind by the economic recovery in the eurozone. However, there is more to it. Despite Draghi's comments and US inflation figures, the euro-dollar exchange rate is not shrinking. The main cause is Trump's policies. His plans to cut taxes and increase government spending are pushing up the budget deficit. This makes parties more reluctant to put their money in US government bonds.

Undercut dollar value
A second way in which Trump undermines the value of the dollar is his way of governing. He creates uncertainty with his messages on Twitter and does not care about the advice of his employees, who also have little job security. The resignation of economic adviser Gary Cohn on March 7 led to a fall in the stock market. Earlier this week, Trump fired Secretary of State Rex Tillerson.

President Trump's unpredictable course suggests that a dollar recovery will take more than a few Fed rate hikes.

Lawrence Martins

Laurens Maartens is a currency expert at the Dutch Payment and Exchange Company (NBWM). Maartens analyzes current currency developments and also provides lectures and training in the field of currency management.

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