May 04, 2020 | International (Global) Strategies

Everything changes when the US Dollar does...

COVID-19 is changing everything at an extraordinary speed, including the outlook for global currency markets. This means that international companies should plan forward and consider what new scenarios may play out over the next 6-12 months, and their potential impact.

We’ve seen the economic fallout already. However, this article aims to address what happens next if the world’s number one currency – the US Dollar – moves into a new long-term trend? What will this mean for the world and everyone dependent on foreign exchange?

Before we analyse this, let’s start with how we got here first.

By Boris Kovacevic, Currency Strategist and Nawaz Ali, Head of Insights

2019 – the first contraction in ten years

Even before COVID-19, the world economy was already struggling. A more than two-and-a-half-year US-China trade dispute had visibly weakened economic activity before the ceasefire was signed in January 2020. As a consequence of this economic and diplomatic quarrel, trade barriers had grown so high that the realised effect was the first contraction in global trade volumes last year since 2009 - according to CPB’s World Trade Monitor. The global manufacturing industry, with all its dependencies on the movement of goods and a working supply chain, also found itself under increasing pressure. Manufacturing in 2019 actually fell into a recession for the first time since 2012 according to J.P. Morgan’s global index1.

Furthermore, for the first time in the 300-year old history of monetary policy, countries and companies could no longer solely rely on central banks to act as the lender of last resort. Countering the economic collateral damage caused by the US-China trade war, and the general slowdown in global growth, central banks had already used up a great deal of ammunition. As part of a global monetary easing cycle, central banks collectively were forced to cut interest rates 132 times last year – nearly three times more than the 46 rate cuts in 2018.

Then COVID-19 accelerates the trend  

Many forecasters widely overlooked these uncertainties and generally assumed a common optimistic conclusion: the global economy would grow faster in 2020 than in the previous two years. This assumption was underlined by the International Monetary Fund’s own forecasts in January. According to the IMF, if world GDP for 2019 was 2.9%, then the global economy should grow by 3.3% this year and then by 3.4% in 2021.   

At the time, we didn’t think these 2020 forecasts would simply collapse in only the first month of the year, and that US-China tensions would be replaced by the coronavirus - a global health crisis hitting all of the world’s five continents and causing more than 70,000 fatalities in only three months2. Consequently, within three weeks of February, the leading stock indices in the UK, Germany, France and the US lost over 30% of market capitalization - officially classified as a ‘bear market’3. Complete public lockdown strategies, critically required to mitigate COVID-19 and save lives, means that economic recessions – not growth - are now expected across major economies in 2020. 

Now the surge for dollars and ‘liquidity’ begins 

The severe economic damage from COVID-19, coupled with historically high valuations of global equity markets, caused volatility to surge across all asset classes. To help underline the gravity of this, the volatility index (VIX) for US equities – known as the fear gauge on Wall Street – surged by the most since the Financial Crisis of 2008. Typically in a crisis like this, you expect to see sustained high demand for traditional safe haven assets like government bonds, gold, and currencies like the Swiss franc. However, what we have seen primarily is a sustained high demand for ‘liquidity’, not safety, amid fears of a global shortage of cash.

This intense ‘flight to liquidity’ and cash is characterised by an increased risk of credit defaults by troubled companies who have no one to sell their debt, products or services to. For example, there is no way for many companies to replace missing sales and profits in service sectors like travel, leisure and tourism. With no revenue but ongoing operational costs and debt repayments, this increases the risk of bankruptcies and puts pressure on the banks that have lent to these companies. Also, high levels of price volatility and risk, and little certainty of assets holding value are also contributing factors behind this ‘dash for dollars’.

The uncertainty meant that everything that could be sold for the US Dollar was being sold, catapulting the US Dollar’s trade-weighted index to a three-year high in March, and not far from its peak back in 2002. It’s why on March 19th the US Federal Reserve allowed an additional nine central banks emergency access to ‘swap lines’ totalling $450bn, ensuring the world’s US Dollar-dependent financial system wouldn’t collapse and halt the supply of credit to households and businesses.

Why does everyone need dollars?  

If you look at this from an international trade perspective, in almost 40% of all global cross-border transactions the US Dollar is exchanged hands4, and more than half of goods imports arriving into the EU are invoiced in USD. We won’t bore you with economic theories like the ‘law of Grassman’, but essentially if you want to trade overseas you need dollars, and if your business is based in emerging markets like India for example, you’re almost forced to invoice in USD instead of your own currency. Therefore, if people believe the US Dollar will appreciate, they’ll want to anticipate this trend and buy the currency now which consequently then pushes up its value even further.

The dominance of the US currency doesn’t just stop there though and extends much further when you look at financial markets. Nearly two thirds (63%) of global debt is denominated in US Dollars[5], and dollar-denominated debt held by non-banks outside of the US exceeds $11 trillion which is the equivalent of 14% of world GDP[6]. Furthermore, the US government bond market, that is considered the safest of assets by other central banks and government institutions, totals $21 trillion. US stock markets account for 54% of global valuations[7], the dollar is the number one reserve currency held by world central banks, and so the list just goes on. The point is, above everything else, the world needs the US Dollar.

Chart sources:, Refinitiv, WUBS – 01042020

Will the US currency continue to appreciate?

If this flight to liquidity remains intact, and US Dollar demand continues to rise, we may potentially be looking at a EUR/USD exchange rate close to parity by year-end. How? Investors are worried that the US – the world’s biggest financial centre – may trigger a credit crunch, adding to the health and economic crisis we have already. This is one reason why the US Dollar could be on the cusp of a major sustained appreciation in value.

An additional factor supporting this outlook is central bank intervention, especially in Emerging Markets. Based on IIF data, $83 billion of capital was pulled out of emerging markets in March alone. Therefore, to fight against currency depreciation, some central banks had to buy their own currency using their FX reserves. During this process, US Dollar reserves needed to be maintained so many eventually drained Euro reserves. What data supports this? Cross-currency swap basis - a well-known indicator of demand for the US currency which shows the premium that non-US foreign banks will pay to exchange their own currency for the US Dollar - rose to an 8-year high last month.[8]

Why? Take a look at US corporate bonds, a market worth 8 trillion dollars. Now if you notice the FRA-OIS spread[9] in this market - that’s just technical speak for the level of unwillingness and cost of US financial institutions to lend to one another – this jumped to a 10-year high in March and could increase further. There is hope though. To counter this type of systemic risk that could lead to a sustained appreciation in the US Dollar, on March 16th the US Federal Reserve slashed its benchmark interest rate to historical lows of 0-0.25% and injected more than $1.5 trillion into financial markets. There are other emergency measures in place now too.

Stimulus may actually devalue the dollar

In global foreign exchange markets, a currency’s outlook is always a two-sided story. Many economists see COVID-19 causing aggressive but short-lived ‘v-shaped’ recessions in the major economies. This potential v-shaped recovery means that whilst economic activity may contract aggressively for a short period, soon after you should expect a very aggressive and short-lived economic expansion. The rationale here is that analysis of historical short recessions and previous pandemics like SARS in 2003 suggests that most economic activity will be delayed rather than destroyed entirely, boosted by government stimulus measures.

Another view is that if you see COVID-19 as a one-off natural disaster, then these do not normally lead to long-term economic depression. Meanwhile, a collapse in oil prices should also be considered a major economic stimulus, if global demand picks up again.

Furthermore, interest rates anchor long-term currency trends. A v-shaped recovery, and the anticipated start of an economic expansion would likely be accompanied by a re-allocation of money back into higher risk and higher yielding assets and currencies. In other words, we could see a major shift back out of the US Dollar if worries about liquidity and safety diminish. If and when the COVID-19 recovery begins, then currencies with an interest rate advantage against the US Dollar will be highly sought after in the years ahead. But this ‘interest rate advantage’ may not necessarily apply to all currencies.

Chart sources: US Federal Reserve, Refinitiv, WUBS – 01042020

Companies should prepare different scenarios

Looking ahead, we understand there are many unknowns still, as well as other global factors to consider. For example, will global emergency stimulus measures help mitigate deep recessions? What if a European government faces financial difficulties like in the past? What about Brexit and the upcoming US election?

In times of heightened uncertainty like we have today, and potentially several more months yet, unfortunately financial decision makers must still plan forward. To help, here are some recommendations to consider:

  1. As part of each company’s urgent COVID-19 response and forward planning, decision makers should assess how this crisis may evolve, and conduct various types of scenario testing. One of the economic inputs for companies with cross-border cross-currency needs will be FX scenarios.
  1. Future scenario planning is a highly effective tool for companies to develop strategies; however, the aim of FX scenario analysis is not to try and predict the future, but rather anticipate what might happen in such a volatile currency market. It requires imagining all possible outcomes, both positive or negative, and forming a wider picture of the future.
  1. If this process uncovers that your company may be exposed, you may need help with developing a counter strategy. Consider seeking further guidance on what types of currency products and strategies are available for companies with material foreign exchange needs.

If your company requires support with COVID-19 response planning, then don’t hesitate to contact our solutions experts to see how we help up to 60,000 companies worldwide across different sectors with currency insights and solutions. Alternatively, visit our blog to see our latest COVID-19 content.   

1 J.P. Morgan – Global Aggregate Purchasing Managers Index
2 World Health Organisation
3 Refinitiv
4 Bank of International Settlements, OECD
5 The Institute of International Finance (IIF)
6 International Bank of Settlements
7 Statista
8 The Institute of International Finance (IIF)
9 Spread between expected 3m interbank interest rate (Libor) and overnight index swap rate on the US interest rate – source Refinitiv, March 2020


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