Why Dollar's Falling With Bond Yields Surging

February 02, 2018

The U.S. economy is heating up, and consumers are the most confident they’ve been since the year 2000. It’s a bit puzzling then that the U.S. dollar recently made headlines for falling to a three-year low.

The greenback is already 3.5% lower than where it started 2018 and 14% below its peak of last year.

Why is the buck falling if the U.S. economy is doing so well?

It could be because, as impressive as growth in the U.S. has been recently, economies elsewhere are performing even better. Earlier this week, it was reported that the 19-member eurozone economy expanded by 2.5% in 2017, the fastest rate since 2007, and ahead of the 2.3% expansion the U.S. saw last year.

The good news has prompted speculation that the European Central Bank could end its quantitative easing program sooner rather than later. The ECB cut its monthly bond-buying pace in half to 30 billion euros starting in January.

A Reuters survey of economists showed 90 % of them predicted the central bank will end the program completely by the end of the year, with a sizable number of respondents anticipating an end to QE as early as September.

Key Factors

Economic growth, interest rate differentials and inflation are three factors that drive currency movements, according to Kevin Flanagan, senior fixed-income strategist at WisdomTree.

Most of those factors are working in favor of the euro, which is the dollar’s biggest rival, making up 58% of the widely followed U.S. Dollar Index. The surprise factor (that few anticipated Europe to be doing as well as it is) is also spurring the euro higher against the dollar.

On the monetary policy side, the potential end of the ECB’s massive QE program is seen as more significant than the likely two or three rate hikes by the Fed this year, which is another boost for the euro.

It’s not just Europe. Japan is also in the midst of a strong expansion, with GDP growing for a record-setting seven-straight quarters through last September, putting pressure on the Bank of Japan to tighten the monetary spigots, as other central banks have done.

Meanwhile, emerging markets are forecast to grow at their fastest pace in five years in 2018―4.9%, according to the IMF―adding fuel to the fire in emerging market currencies. The WisdomTree Emerging Currency Strategy Fund (CEW), which tracks a basket of 15 EM currencies, is up 2.9% already this year on top of last year’s 11.1% gain.

Bigger Picture

It’s important to put the dollar’s latest decline into perspective. For three-straight years—between 2014 and 2016—the greenback surged higher as the Fed ended “QE3,” the stimulus program that had the U.S. central bank buying as much as $85 billion worth of government bonds per month, and did away with the zero-interest-rate policy that was in place since the financial crisis.

The Fed began tightening monetary policy just as other central banks were loosening theirs (the ECB began its QE program in 2015). The relatively hawkish policies of the Fed compared with other central banks pushed the U.S. Dollar Index to a peak of just under 104 on the first trading days of 2017, the highest level for the index since 2002.

The recent decline in the dollar is coming off those lofty levels; the U.S. Dollar Index is still trading more than 10% above where it was when the post-QE3 run began in 2014, and more than 25% above the low of the past decade (set in 2008).

 

US Dollar Index

 

 

Find your next ETF

CLEAR FILTER