In spite of all this economic outperformance, the US dollar has hardly budged this year.

US growth this year is likely to be four times faster than that we see in the UK and euro zone. Only Japan of the major nations looks as if it can keep up but even it is likely to be short of the 2%-plus growth we are likely to see for the US this year. But in spite of all this economic outperformance, the US dollar has hardly budged this year. The dollar’s DXY index, which measures the greenback against other major developed currencies, is the same level today as it was at the start of the year and, in between times, has only deviated a few percentage points each side of current levels. Why has US economic outperformance not spurred dollar strength, especially given that analysts’ forecasts for US growth this year started 2023 at less than half a percent?

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, thinks that there are two primary reasons for this. The first is that it is not abundantly clear that countries with faster growth achieve currency strength. For instance, if strong growth is ‘bought’ with injudiciously loose fiscal and/or monetary policy then it seems more likely that the currency will fall and not rise, at least in the long haul as the costs of striving for faster growth are laid bare through consequences such as rising inflation and/or fiscal tensions. And while we might most often ascribe this sort of ‘false’ strength in growth as likely to be found in the developing world, it can happen amongst big, developed countries as well – even the US. For there is little doubt in our mind that much of the US’s economic outperformance has been ‘bought’ by significant fiscal largesse.

This was seen during the pandemic, when US stimulus was generally larger and more direct than other countries, and it has continued subsequently in the shape of new legislation such as the infrastructure plan and the inflation reduction act. This has meant a significant transfer from the public sector to the private sector, both directly in terms of people’s income and indirectly because it has aided asset prices, notably stocks, with the doubling of the S&P 500 since the lows seen during the pandemic more than we’ve seen for other major developed countries. The corollary of this is that household net financial assets have surged in the US but stalled in Europe.

While this rise is good, the market has its concerns about the fiscal ramifications, especially given that we are going into an election year when nothing typically happens on the fiscal front, let alone meaningful deficit reduction. And even after the election there seems little hope that fiscal largesse can be corrected, unlike Europe, for instance, where the UK faces a large post-election spending squeeze and EU officials are currently hammering out a plan to get fiscal consolidation back on track. It might prove the case that more natural or organic growth in the US develops and helps pay down the debt. But the lack of strength in the US dollar this past year suggests that the market is not too hopeful on this score.

The second reason why the dollar has not rallied in spite of this growth outperformance is that the market still believes that the Fed will cut rates next year, and not too long after some of the other central banks are forecast to start their own rate cuts, like the ECB. As long as Fed rate cuts appear likely the US dollar should languish because easier global financial conditions are most often associated with stronger asset prices– and a weaker dollar - as a result.

Of course, it could be different this time if easier policy fails to lift asset prices. But it looks to us that sustained dollar strength from here is only likely if all speculation of easier Fed policy disappears, and particularly if US rates have to be raised again. That is a risk, not least given the fiscal largesse and strength of household balance sheets – but it is not the Standard Bank’s base-case scenario.