USD rose strongly in the early 1980s. Could this scenario happen again?

Quite clearly, 40 years, or more, is an extraordinarily long time in the foreign exchange markets and the global economy more generally. But does that mean that we should ignore the history of the early 1980s? After all, it is the period that seems most akin to today, what with an energy crisis, soaring inflation, and fast policy tightening.

This period also marked an extraordinary rise in the dollar. It was by far the most rapid rise in the dollar seen since the advent of floating exchange rates in the early 1970s and took the dollar to arguably the most overvalued level that we have ever seen.

It was also a time when major policymakers had to come together to reverse the dollar’s surge with hefty intervention. Fast forward to today, and nobody is anticipating a similar-sized surge in the dollar or coordinated intervention. But could this prove complacent?

Our recollections of the dollar’s strength in the early 1980s had more to do with aggressive Fed tightening and significant easing of US fiscal policy under the Reagan administration than the surge in oil prices in the early 1970s and then again in the late 1970s.

The current situation seems to have more to do with energy prices given that strains have been particularly acute in Europe relative to the US because of the proximity of the Russia/Ukraine conflict, and because the scale of increases this time is so much greater.

For instance, oil prices rose by around 2.5 times between the start of 1979 and the spring of 1980, while European gas prices are up a phenomenal 5.5 times over the past year. Perhaps, in theory, this would seem to justify more dollar strength now against European currencies than we saw in the early 1980s—when the dollar doubled in value against the German deutschemark between 1980 and 1985!

However, on the flipside, fiscal activism appeared to be more significant in the early 1980s than it is now, as former President Reagan’s Economic Recovery Tax Act of 1981 cut personal taxes aggressively and arguably fanned higher inflation, forcing the Fed to be more aggressive with rate hikes.

Coming back to today, soaring inflation and aggressive rate hikes have not lifted treasury yields – and hence the attractiveness of the dollar – in the same way that we saw in the 1980s. Back then, real 10-year treasury yields were mostly positive as opposed to real 10-year yields now, which are negative to the tune of around 5.5% using current CPI data as our proxy for inflation expectations.

Another issue to consider is the possibility of currency intervention should the dollar become exceptionally strong. In 1985, when major-country finance ministers got together to launch currency intervention, there was no real history of such action. In other words, those traders buying dollars through much of the early 1980s were not fearful that the greenback’s rise could be met with intervention. This appeared to galvanise the dollar bulls, but also exacerbated the slump in the dollar when intervention finally arrived.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said fast forward to today and, while we’ve not seen coordinated intervention for a very long time, the market is more cognizant of the fact that it could occur again if push comes to shove and this, in turn, could supress some of the bullishness towards the dollar, if not now, then certainly in the future.  

"While the 1980s might not provide a perfect template, we still think the conclusion is that the 80s won’t be repeated. This is not the same as saying that the dollar will fail to rise – because it probably will appreciate further; just not to the extent we saw 40 years ago, and hence probably not necessitating the involvement of G10 central banks via FX intervention", said Mr. Steve Barrow.