US dollar could be a ‘CRASH RISK’ amid rising economic & political uncertainty

After suffering its worst monthly fall in about a decade, the US currency has started August with a bounce. However, analysts predict further weakness in the greenback.

“We expect the currency to be undermined by an ebbing of safe-haven flows, a reduction in the US rate advantage, and political uncertainty ahead of the November presidential election,” UBS analysts wrote last week.

The ICE US Dollar Index, which measures the dollar against a basket of six major rivals, plunged 4.2 percent in July – its biggest one-month decline since September 2010, data showed. The index was trading up on Tuesday at around 93.69, but data from the Commodity Futures Trading Commission showed that the dollar is well out of favor with speculative traders.

According to Steven Barrow, head of G-10 strategy at Standard Bank, the dollar’s weakness versus developed currencies comes at a time of heightened global uncertainty surrounding the Covid-19 pandemic. Usually, the dollar behaves “a bit better” against its developed-economy peers during a crisis, he said in a note seen by Market Watch.

The strategist worries that the combination of rising economic and political uncertainty amid the coronavirus pandemic and ahead of the November presidential election could pose a so-called “crash risk,” a danger more often associated with emerging-market currencies.

Barrow noted that the dollar has held up well versus emerging-market currencies, which means the risk may be mainly against other developed-world currencies, like the euro, Japanese yen and Swiss franc.

Interest rate cuts and other easing measures by the Federal Reserve, as well as the drop in Treasury yields to or near all-time lows, have significantly reduced the US rate premium versus other “safe” currencies. What’s really important, according to Barrow, are other factors, like the liquidity of assets, particularly government bonds. The near-freeze-up of the US Treasury market at the height of the Covid-19 crisis earlier this year marked a “bit of a wobble,” he said. That could be a problem if it makes traders and investors reluctant to head for Treasuries in the event of another risk-off event.

The Economic Uncertainty Index showed that US uncertainty has soared to levels similar to those in the rest of the world, while it had been significantly below global levels before the pandemic.

According to Barrow, there are other factors that could lead to dollar weakness, but the underlying question is whether the dollar can be trusted. “For if trust has disappeared in the US’ economy, policy making, election credibility and more, then the dollar could be in for a slump, at least against other major currencies,” he said.

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