Maybe the US isn't so far ahead of the pack. Why the US dollar is suddenly struggling

Author: Adam Button | Category: Central Banks

Delta and bottlenecks level the playing field

Vaccination rates
One way to think of the foreign exchange market from the bottom of the global economic cycle is a race.

Who will emerge first? Who will normalize first? Who will overheat first?

For much of this year the US and the dollar were good bets. The US had access to vaccines first, there was strong fiscal stimulus and inflation was in the pipeline.

The market is increasingly questioning those assumptions.

1) Vaccination

Delta has changed the game, raising the threshold for herd immunity and sparking new questions. The vaccination time gap between the US, Europe and others matters less and the vaccine take up matters more. Ultimately, a country having to wait 6 extra months for vaccines but getting 80% take up compared to 60% in the US is a loss for the dollar. Powell brushed aside economic risks related to delta but if there's a worse variant in the future, low vaccination rates will be problematic and that risk is being priced into the dollar. Is it a surprise that GBP and CAD are outperforming this week?
Fed building
2) Fiscal stimulus

US employment support programs run out in 5 weeks. The bipartisan infrastructure deal looks to be done but a second package through reconciliation will be a struggle. It's impossible to say how it shakes out but the tide may be turning on US spending. To be fair, it's a similar story in most countries and tax hikes are in the pipeline but what was once a potential US advantage is more of a question mark.

3) Bottlenecks

Today's GDP data was disappointing and a big reason why is continued inventory drawdowns. That is frustrating business and consumers, turning what might have been a reopening boom into more of a slow burn. For the rest of the world, that leaves a larger window to catch up to the impressive growth track the US is on. The sequencing may also be important for central bank perceptions.

4) Transitory factors

Dollar Index
The US reopening coincided with positive base year effects in inflation so there was a double-whammy for inflation that made the market (and some FOMC members) consider moving more quickly. As the boom and the bottlenecks, recede at the same time there's a good chance that US inflation will undershoot at this time next year. Contrast that with a later reopening elsewhere and inflation rates may converge. That will reel in expectations that the Fed will be much quicker to hike.

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