Market Overview

13 January 2021

Fiscal Stimulus in the U.S. May Ultimately Strengthen the Dollar

A common place in the financial markets in the last months is the sentiment that the U.S. Dollar is poised to a further decline against other major currencies. Among other arguments put forward by investors were the combination of the Blue wave of Democratic dominance in the Congress of the United States and dovish monetary policy from the Federal Reserve (Fed).

It is a fact that the presidency of Democrat Joe Biden is accompanied by the takeover of the majority in the Congress by Democrats. This would likely lead to the substantial increase of fiscal stimulus that Democrats had consistently declared in 2020. These fiscal stimulus measures seem to be seemingly amplifying and supplementing an unprecedented loss of monetary policy which is run by the Fed. The U.S. monetary policymaker has declared that close-to-zero interest rates could last at least until 2023, and is not showing any signs of lowering the amount of monetary stimulus, which is $120 billion a month.

However, the synergy of these two waves of fiscal and monetary stimulus may not come full circle. The Fed launched its full-scale quantitative easing vehicle last spring, along with the first wave of coronavirus, long before elections in the United States took place, and before even considering the fiscal stimulus from U.S. Administration. The Fed took action of its own accord according to its mandate in order to tackle the unexpected economic crisis. These monetary measures engaged weakness of the Greenback as the U.S. Dollar index plunged from 104 points in March to 93.3 points on the day before the elections. Fiscal stimulus was only largely debated by then without any particular financing, but even expectations facilitated the weakening of the American currency.

But the situation changed in early 2021. The fiscal stimulus program has several consequences. On one hand, it would mean increasing monetary supply that could severely pressure the Greenback. Even debates on this matter made was seen to cause the U.S. Dollar index to slide below 90 points over recent weeks. However, fiscal stimulus would probably not result in the printing of new additional Dollars, as would probably be the case with the Fed’s monetary stimulus. So, sources point to fiscal stimulus consisting of the increase of government borrowings and rising taxes, which is in line with Biden’s declarations ahead of last year’s elections. And if so, rising government debt may be largely anticipated as well as the rising yields on it. That is exactly what happened at the start of 2021 when U.S. 10-year Treasuries yields soared from 0.93% to above 1.127% this Wednesday. This can be seen as a key driver for the strengthening of the Dollar.

Rising taxes announced by President-elect Joe Biden is a hefty factor that is seen to slash corporate profits that may hammer stock indices rally and support the Dollar too. This move is inverse to the fiscal stimulus as the government is supporting the economy by providing relief money , and it will probably eventually withdrawing money from the economy by addition taxations. Paradoxically, in order to increase monetary supply in the economy, the government has to decrease it first. So, the Greenback may enjoy this sunny side of the stimulus too.

Finally, the fiscal stimulus may soften the Fed’s monetary stimulus as they are both targeting the support of the economy. So, if the U.S. economy would demonstrate strong signs of recovery in 2021 following this double stimulus measures, the Fed may lower the amount of debt loaded on its balance sheet. Atlanta Fed Chief Raphael Bostic said that if the economy snaps back quickly this year, the Fed may be able to start paring back its bond-buying stimulus efforts later in the year. He was supported by another Fed President from Dallas, Robert Kaplan, who expects broad vaccine distribution to unleash strong economic growth later this year, something that may allow the U.S. central bank to begin to pull back on some of its extraordinary monetary support.

Consequently, the interference of the U.S. Treasury in the stimulus race may in spite of initial expectations strengthen the Dollar instead of weakening it. However, it is not a short-term process and the process may unwind fully over the course of several months. Considering the record decline of the Greenback to the lows of 2018, further weakening of the Dollar could be rather limited at the moment.

In addition, there are prerequisites to support this point. Interest rates in the United States are more attractive then over the pond in Europe or in Japan. Dollar-denominated assets are consequently more attractive with a higher return than its peer assets elsewhere in developed countries. The strengthening of other major currencies may trigger actions from central banks in order to support domestic exports and economies with the Euro, British Pound, Japanese Yen and the Swiss Franc, while also monitoring them. 

Clearly, the avoidance of  risky investments and the monetary stimulus are two topics that are seen as top priorities now, and which may drag the U.S. Dollar index further down to its technical support of 88.1 points. But, this landmark support may finally terminate the massacre of the Dollar and reverse it to the upside.


Disclaimer:

Analysis and opinions provided herein are intended solely for informational and educational purposes and don't represent a recommendation or investment advice by TeleTrade.


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