HomeTrade-Weighted US Dollar Downtrend Continues

Trade-Weighted US Dollar Downtrend Continues

The trade-weighted US dollar may decline as much as 5% year-on-year by mid-Summer. What does it mean for investors fearing higher inflation?

The US dollar continues its decline following worse-than-expected jobs data for April. The May 2021 NFP report showed that the US economy added fewer jobs than economists forecast.

The weak number was not the result of the US economy’s inability to create jobs, but rather people’s unwillingness to get a job. In many cases unemployment benefits are higher than what most people earned when working before the pandemic.

As such, the unusual situation led to an unusual market reaction. Why unusual? Because the dollar has been declining for several weeks now – the EUR/USD exchange rate has moved from 1.17 to 1.21 since the start of April. During that time, market sentiment was fueled by a stronger economy and a presumably healthy job market. Yet, when the data showed the opposite, the dollar fell. Once again, the market’s reaction shows us the complexity of the “trading game.”

Plentiful Jobs, But Hard to Fill

Following the NFP report, it became clear that jobs are plentiful but hard to fill. People are not willing to work for the same pay as before, especially because of inflation fears.

The Fed hinted that inflation would exceed the 2% level when it changed its mandate in 2020. Now, the Fed aims at averaging 2% over a period of time, meaning it will permit an inflation rise above this level. For how long and by how much remains to be seen.

In the meantime, employers face a tough call – pay more as wage growth pressures rise fast, or keep struggling to find staff. Hiring and firing is an expensive procedure, which is one of the reasons why the unemployment rate is a lagging indicator. Therefore, when faced with labour force shortages, the easier path for employers is to simply offer higher salaries.

The Fed is in wait-and-see mode, saying multiple times that inflation is transitory, which it may well be.

In the meantime, if the trade-weighted US dollar holds at current levels, by mid-summer it would have declined by 5% YoY. That would be another inflationary impulse stemming from higher import costs.

In short, the US economy is at a crossroads. On the one hand, it rebounded so fast from its lows that now it has a hard time filling the jobs this rebound created. On the other hand, the weaker currency is helping to boost exports, while reflecting inflationary pressures.

The rest of the year will end up shaping the US economy for years to come. Make no mistake, the Fed is watching closely.

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