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As America digs out of recession could it push the U.S. dollar into a hole?

Once high flying, the U.S. dollar has veered south, putting early year gains at risk.

The economic damage from the COVID-19 has been widespread and staggering.
The economic damage from the COVID-19 has been widespread and staggering.

The initial outbreak of the COVID-19 pandemic led to a significant spike in the greenback, the world’s most liquid currency. Safe haven flows amid worries about major economies taking unprecedented plunges unleashed voracious demand for the U.S. currency while sending risk assets into a tailspin.

Fears about a deep global recession sent the greenback soaring to three- and four-year highs against the euro and Canadian dollar, respectively, and to 18 and 35-year peaks against rivals from Australia and Britain. Against the emerging market Mexican peso, the U.S. currency registered all-time highs.

The steep drop in economic activity related to COVID-19 led central banks around the world to slash borrowing rates and deploy other growth-friendly measures. With the world’s monetary spigots wide open it helped inject calm into wary markets. Such lavish levels of monetary stimulus helped markets regain some composure, tempering safety flows into the dollar.

To be sure, Wall Street enjoyed a banner April when the S&P index soared 13% for its biggest monthly gain in over three decades.

Consequently, the U.S. currency has surrendered ground since peaking in March. The greenback has revisited the lower end of its ranges against its chief rivals from Europe and Canada.

The economic damage from the COVID-19 has been widespread and staggering. The world’s biggest economy contracted by 5% in the first quarter with some forecasting a second quarter plunge of around 30-40%. Hiring took a record tumble of more than 20 million in April, sending unemployment to nearly 15%, the highest since the Great Depression.

But hopes of a V-shaped recovery, which have flickered, gained traction after hiring stormed back with a record surge of more than 2.5 million in May, a surprise increase that lowered unemployment to a still-high 13.3% from 14.7%. Earlier this year, before the virus, American unemployment was at 50-year lows of 3.5%.

While encouraging and a sign that recovery from recession may already be under way, potential threats to growth remain. Among them: renewed trade tensions between the U.S. and China, the world’s No. 2 economy, social unrest across America that could slow the reopening of businesses, and the risk of a second wave of the COVID-19.

While the U.S. currency has lost altitude, the fact that the economic outlook remains highly uncertain could help to limit bouts of weakness. A more cautious environment for risk taking would be supportive of more conservative bets like the greenback. Fed Chairman Jerome Powell in June warned that the recovery could be slow and potentially protracted.

The greenback has at times correlated negatively with Wall Street where improved risk appetite and stock market gains have dampened demand for the dollar. But that correlation could break down, particularly if the U.S. economy goes on to show a relatively quick comeback from recession.

Signs of strengthening U.S. economic fundamentals could spur fresh buying of the dollar on the view that the U.S. might lead a global recovery.

In the meantime, the road ahead may prove a bumpy one for both the dollar and the world’s biggest economy.  

Data source: Reuters