How Weak is the US Dollar really?

It's not as weak as the headline numbers suggest...

The Dollar has fallen sharply since the inauguration on January 20, which has given rise in some circles to a lot of negative commentary, including speculation that the US is losing its reserve currency status. Before we go down that road and start painting all kinds of doomsday scenarios, let’s make sure we have the numbers right. That’s what this post attempts to do for the recent Dollar decline.

Exchange rates are always the product of two things: (i) how the domestic economy (in this case the US) is doing; and (ii) how foreign economies are doing. Let’s look at the US Dollar in recent months and disentangle these two forces.

There’s been four distinct phases in the Dollar since election day. The first begins on Nov. 5 and runs through Jan. 20. This phase saw the Dollar rise around 6 percent against other advanced economies (black line) and was basically about markets expecting Trump 2.0 to be good for US growth. The second phase saw the Dollar fall around 2 percent around on-again, off-again tariffs on Canada and Mexico in early February. This is the first time the Dollar reacted negatively to US tariffs, which is noteworthy because the Dollar should go up in reaction to US tariffs. The third phase saw a more precipitous fall in the Dollar in early March, when Germany announced its surprise fiscal stimulus. This fall wasn’t about the US and therefore shouldn’t count as Dollar weakness (instead, this was Euro strength). Finally, the fourth phase began with “Liberation Day” on April 2 and is ongoing, with another 4 percent drop in the Dollar that was especially acute around April 9, when reciprocal tariffs were rolled back.

The Dollar against advanced economies - what’s called the G10 - is now down 4 percent, which means - peak to trough - the Dollar has fallen 10 percentage points since inauguration. 4 percentage points out of this drop are about Germany’s fiscal stimulus, so genuine Dollar weakness is only worth around 6 percentage points. In other words, the Dollar is basically flat since election day: it rose 6 percent before inauguration and has given all that rise back. That’s also the picture that an index of the Dollar versus emerging markets (EM) paints. That index (blue line) is basically flat since election day, so it’s hardly right to think of the US Dollar in any kind of free fall.

None of this is to dismiss or make light of the fact that the Dollar fell around US tariff announcements. Those declines are highly unusual and worrying. I’ll write about those and how worried they should make us in my next post…