U.S. commercial activity is reflating back toward pre-pandemic levels. The recovery is showing up in the high frequency data and in an array of anecdotal evidence. Automobile traffic is increasing, for example, and container ships are backed up in San Pedro Bay, waiting to be unloaded at Southern California seaports.
Underneath the recovery are nascent signs of increased demand for the dollar. We expect the real effective exchange rate of the greenback to advance in value against a trade-weighted basket of currencies as growth and interest rate differentials drive capital flows into the U.S. this year.
As with all commodities, the value of the dollar is determined by its demand. For instance, if dollar-denominated oil transactions suddenly come to a halt, as they did a year ago, then the demand for dollars would be expected to drop, diminishing its value.
If vaccines continue to be administered and the economy recovers, expect the dollar to move higher in the medium term.
Similarly, if sales of imported goods are transacted in dollars, then holders of those profits would be likely to park those funds in dollar-denominated securities — the highest rate of return and the safest investment in the world. That, in turn, pressures the demand for and the value of the dollar higher
Predicting the direction of the dollar is tricky, however, if only because the value of a currency is also determined by the demand (or lack of demand) for the other side of the currency.
For instance, if Europe’s vaccination efforts were to stumble, we might expect the American economy to support higher interest rates and for the dollar to gain on the euro.
And if emerging markets were to lack the facility to vaccinate, we would expect the dollar to gain on developing-market currencies to the extent that those currencies aren’t buoyed by demand for their commodities.
We think it is safe to say that if vaccines continue to be quickly administered to the U.S. population and as the U.S. economy comes out of the doldrums before other economies, the value of the dollar will move higher in the medium term.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
