Bear Mountain Capital Inc.

Why Is The Dollar In a Free Fall Against the Euro and the Pound?

| February 12, 2018

Economy

Every now and again, we get questions from clients that we think we should share. In this post, we respond to the question in the subject line: why is the dollar in a free fall against the euro and the pound?

To be sure, the US dollar is currently not in a “free-fall”. However, it is fair to ask what is behind last years drop in value of the US dollar relative to other currencies. First, currency fluctuations occur for many reasons. The dollar’s strength against the euro and the pound peaked (if you are looking at the 10yr chart) right around December of 2016. And yes, since that time period, we’ve seen a steady decline in the value of the dollar to the euro, pound and almost all other major currencies, as well.

There is no one reason why the dollar is “weaker” than these currencies, than it was prior to the end of 2016. It’s a combinations of inflation in the respective economies, differences in interest rates, trade policy, public debt, current account deficits and political stability and economic performance.

It’s important to remember that currency values can also change in the short-term based on confidence or sentiment alone. What this means, is a drop in the dollar in a short time period can be caused by political rhetoric about trade policy, or legislative agendas that may affect public debt. However, these are usually short-lived currency movements. The combination of the factors above will drive the long-term trend.

As an example too much public debt can lead to weaker dollar, protectionist trade policies can lead to a weaker dollar, high current account deficit (meaning you import more foreign goods than you export domestic goods) can lead to a weaker dollar, political uncertainty or instability can lead to a weaker dollar, and/or higher expected inflation in US economy can lead to a weaker dollar.

Again, its not just one thing that causes the movements. However, a weak dollar is not necessarily a bad thing either. A weaker currency can be helpful for US manufacturers exporting overseas. It can also be beneficial to US based investors with international holdings. To understand more how to think about a weak vs. strong dollar, see our previous blog post on the subject: http://bearmountaincapital.com/whats-not-in-a-word-strong-dollar/