over 3 years ago • 2 mins
July was the worst month in a decade for the US dollar, as its value hit a two-year low compared to major trading partners. So we invited in Nordea market strategist Andreas Steno Larsen to explain why anyone should care – and why it may herald a rosy economy on the horizon.
While some observers fret that the declining dollar suggests unprecedented Federal Reserve (Fed) stimulus is undermining its status as the world’s reserve currency, investors shouldn’t freak out, Larsen explained over the phone. After all, a weaker dollar generally shows that investors are more confident about the future, as they’re willing to pull their money from the perceived safety of the US currency.
Meanwhile, Fed stimulus should feed through to stronger economic data in 6 months or so. The huge drop we’ve seen in yields on US government bonds signals a big rebound in economic indicators like the Institute of Supply Management’s (ISM) business conditions report, Larsen reckons.
Central banks must hold strategic reserves of overseas currencies. And, according to Larsen, when they decide on which currencies to stockpile, the dollar is top choice because of: its “big, safe and liquid” bond market, its huge role in cross-border trade, and its power should you need to intervene to move the value of your currency.
The dollar is “still the only currency that ticks all the boxes for a true reserve currency,” Larsen wrote in a report this week. And, historically, increased supply of dollars from the Fed has always been met with demand from foreign central banks willing to buy them up.
Which has led to central banks’ dollar holdings remaining steady over the years.
Larsen reckons that only a major change could endanger the dollar’s status. For example, China would need to build a large and liquid bond market or Europe would need to develop an alternative energy source to oil that was priced in euros.
“It would require that a lot of world trade is suddenly conducted in another currency,” Larsen told us. “As long as everyone trades with each other across borders in dollars, then there is no alternative whatsoever to the dollar as a reserve currency.”
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