Dollar Weakness: A Long-Term Trend or a Temporary Correction?

Bloomberg macro strategist Simon White anticipates continued weakness in the US dollar over the long term. White attributes this outlook to several key factors, including the unwinding of speculative short positions and the deteriorating US fiscal situation amid slowing economic growth.

Failed Rebound Attempts

White points out that the Dollar Index is experiencing another failed rebound attempt. In recent weeks, it has tried for the second time to recover from its early July lows, only to encounter strong resistance. White believes this pattern of failed attempts is likely to persist, as the dollar's fundamentals suggest continued pressure.

Short Position Liquidation

Short dollar trades were previously so crowded that a rebound was only a matter of time. According to data from the US Commodity Futures Trading Commission (CFTC), speculative short positions in dollar futures were extremely large. However, these short positions have been largely unwound.

Shift to Net Long Positions Against Major Currencies

Although dollar positions remain net short overall, short positions against developed market currencies such as the euro and the pound have been liquidated, and positions are now back to net long. However, speculators still hold net short positions against emerging market currencies, and the size of these positions is increasing. But for the Dollar Index, developed market currencies, especially the euro, are the key influencing factors.

Hedge Funds Reduce Dollar Exposure

Macro hedge funds and commodity trading advisors (CTAs) also appear to have reduced their exposure to shorting the dollar. Their earnings sensitivity to dollar performance has fallen to its lowest level in more than three years (a negative value) and has now returned to a neutral level.

US Fiscal Situation Raises Concerns

White believes the US fiscal situation is a major concern. The annual deficit in the United States has reached about $2 trillion. If the economy slips into recession, the deficit, which accounts for 6%-7% of GDP, could easily double to double digits.

Declining Tax Revenues

The risks associated with an economic recession in the United States are increasing. As the economy slows, tax revenues will decline (leading indicators are already indicating this trend), further straining the government budget.

Conclusion: A Dominant Downward Trend

It is true that market movements never go in a straight line, and the foreign exchange market is a prime example of this. But for the dollar, upward movements are likely to become increasingly short-lived in the face of a dominant downward trend. Investors and analysts should closely monitor these dynamics.

The Impact of Geopolitical Factors

In addition to the economic and fiscal factors mentioned above, geopolitical events can also affect the value of the dollar. For example, escalating trade tensions or geopolitical conflicts could increase demand for the dollar as a safe haven, potentially causing its value to rise in the short term. However, White believes these effects will be temporary and the dominant downward trend will ultimately continue.

Investment Diversification as a Solution

In these circumstances, investment diversification may be the best solution for investors seeking to protect their portfolios from fluctuations in the value of the dollar. This could include investing in assets denominated in other currencies, such as the euro or the Japanese yen, or investing in commodities or international equities.