The United States has gone through some tumultuous times in the past few years, with political strife and economic uncertainty dominating news headlines. However, for those watching the currency market, the real story has been the continued strength of the US dollar. In this article, we discuss the reasons behind the dollar’s strength, what it means for the currency market, and how investors can take advantage of these developments.
The Bloomberg Dollar Spot Index, which measures the greenback against other major currencies, has held its value through the first five months of 2023 and is closer to its highs of the year than its lows. Some of the factors contributing to this strength include much higher interest rates in the US relative to other developed countries with the Federal Reserve’s benchmark rate at 5.25%, compared to 3.25% in the eurozone, 4.50% in the UK and Canada, and 0.10% in Japan.
However, according to Citigroup Inc. currency strategists, the desire for dollars is partly linked to the flourishing demand for shares in US technology companies that are seen as the primary beneficiaries of the budding boom in the artificial intelligence sector. Consequently, technology stocks have seen a significant boost, and the Nasdaq 100 Index of tech stocks has surged 33% this year.
The US economy is not just benefiting from the technology boom but has also been boosted by the Inflation Reduction Act of 2022, which has led to massive capital investment. Construction spending by manufacturers in the US has more than doubled in the past year, reaching an annual rate of almost $190 billion in April, according to Bloomberg News. Manufacturing now accounts for about 13% of all non-government construction, the highest share on record in a data series stretching back to the early 1990s. Furthermore, the recent Treasury auctions have seen significant demand from buyers, including proxy buyers for foreign investors, despite fears of a financial crisis.
Countries attempting to move their reserves away from the dollar due to concerns about US sanctions have found this to be difficult. Since Russia invaded Ukraine in February 2022, the use of the dollar in global transactions has grown, according to Swift, the cooperative that provides financial messaging services. The dollar’s share of global payments has remained stable despite efforts to move away from it, with non-US investors owning $7.57 trillion of Treasuries as of March. This should make it easier for the market to absorb the deluge of Treasuries that are coming with the US government now able to rebuild its cash accounts, and the US bond market has delivered superior returns of 2.17% this year, compared to the 1.63% for the global debt market overall.
Lastly, the stock market has had a great year, with the MSCI USA Index gaining 11.8%, compared to the 6.20% increase in the MSCI All-Country World Index excluding the US. The price-to-earnings ratio for the MSCI USA index is 19.4, compared with 13.1 for the non-US index, showing that investors value US shares more dearly.
In conclusion, the sentiment towards the US economy by investors is at a high, with technology, construction, and bond investment all contributing to the robustness of the dollar. The perception may be that the US government is broken, but investors are focusing on American exceptionalism and not the perception of America in decline. Those interested in currency trading should keep an eye on these positive developments and consider ways to leverage this in their investments.