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Twin Deficits and the US Dollar

Twin Deficits and the US Dollar

April 26, 2021
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It was a particularly challenging year for the greenback in 2020, where the world’s reserve currency acted as a “safe haven” asset at the height of the March 2020 market volatility, only to fall over the remainder of the year. With the U.S. outpacing much of the developed world in economic growth in 2021, Treasury yields have been rising and the dollar has strengthened, bucking the consensus view for dollar weakness.

We view the “twin deficits” of the U.S. economy—the combination of the budget deficit and the current account deficit—as a long-term structural driver of a weaker U.S. dollar. As a historical net importer, the U.S. has usually carried a trade deficit (leading to a broader current account deficit in the process), while the flood of pandemic aid has stretched the budget deficit and ballooned the sum of the twin deficits to all-time lows as a percent of gross domestic product (GDP). As shown in the LPL Chart of the Day, changes in the twin deficits have been a relatively accurate predictor in the long-term trend of the value of the US dollar:

View enlarged chart.

With the twin deficits reaching all-time lows, it’s hard to be bullish the US dollar over the long-term relative to its major counterparts. “The short-dollar trade has certainly been a frustrating one for investors this year, but the long-term trend continues to point lower,” added LPL Financial Chief Market Strategist Ryan Detrick. “However, a counter-trend rally like we saw in the first quarter might have been enough to flush out some of the crowded consensus for a lower dollar.”

U.S. economic growth has outpaced our developed nation counterparts to begin 2021, but expectations for growth in the rest of the world may be playing catch up. In particular, the 30-year German bund yield broke out to its highest level since the onset of the pandemic, suggesting growth expectations for one of our major trade partners may be on the rise.

A soft dollar has a variety of investment implications. While we continue to favor U.S. stock market exposure over developed international markets, investments overseas may benefit from the tailwind of the softer dollar. Meanwhile, commodities have historically benefitted from a weaker dollar, and may be positioned for further upside as economic activity in the rest of the world heats up. For more on our tactical market views, check out our April Global Portfolio Strategy.

 

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This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy. All index and market data from FactSet and Bloomberg. This Research material was prepared by LPL Financial, LLC. Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

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