The world loves the US dollar. Trump and the pandemic could change that

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But as the United States battles further Covid-19 outbreaks that weigh on economic recovery, the dollar has fallen. Now, some on Wall Street are warning that it could fall further, in part because of President Donald Trump’s handling of the crisis and isolationist policies.

“We expect the US dollar to follow a path of reduced dominance and to weaken in the long term,” Nomura said in a report to customers on Monday.

The dollar – an important symbol of America’s global position – remains the primary currency of choice for investors, who use it to trade a wide range of assets around the world. It is also the first reserve currency in the world, held in large quantities by governments, central banks and other large financial institutions. Dollar bulls and skeptics note that there is currently no real alternative.

However, investors are becoming less optimistic about the dollar perspective. Growing debt and Trump’s commitment to America First policies have increased the risks. A diminishing role of the United States on the world stage could encourage the Allies to increase their holdings in other leading currencies.

Meanwhile, asset managers like Black rock (BLK) encourage customers to consider investment opportunities in Europe, where countries seem to have better control over the health and economic challenges posed by the virus.

This could hurt the value of the dollar in the months to come, although any substantial change in the global monetary regime would take decades.

A weak perspective

Those looking to bet against the dollar point to worsening economic prospects in the United States, where the number of confirmed cases of Covid-19 has increased to nearly 3.4 million.

As the number of cases in the United States spirals out of control, many states are reimposing tight lockdowns, threatening the fragile recovery that began in April. In California, which has the fifth largest economy in the world, Governor Gavin Newsom closed seats inside restaurants, cinemas, zoos, museums and bars on Monday. At least 27 states have now suspended reopening businesses or reimposed measures to slow the spread of the virus.

“The United States reopened too early, as you can see,” said Nomura strategist Jordan Rochester. “The dollar is expected to weaken in the medium term thanks to Covid’s response. He also noted that unemployment would remain high, an opinion shared by some of the largest US banks.

The economic environment supports the idea that US interest rates will stay close to zero longer, weighing on the dollar. This does not bode well for the country’s growing budget deficit either. US federal debt is expected to reach 101% of GDP this year.

The US government is stepping up borrowing to finance massive stimulus programs to support the economy. the The June budget deficit jumped to $ 864 billion, the Treasury Department announced this week. And this is accompanied by a large current account deficit, which means that the United States spends more on goods, services and investments abroad than it brings back.

Other developed economies also borrow much more. In the United States, the government issues debt faster than the Federal Reserve buys it. This means that there are more US Treasuries on the market, which weighs on the value of the dollar, said Rochester.

Look at the euro

Meanwhile, the euro seems increasingly attractive to some investors. It has climbed about 2% against the dollar so far this year despite a wild recession in Europe.

Rochester noted that high-frequency data suggests that the recovery has stalled in the United States as the country battles new outbreaks, while in Europe, which locked out earlier, activity continues to improve.

There is also optimism that despite their differences, European countries could agree on a recovery plan this month, which would see the block raise 750 billion euros (825 billion dollars) via financial markets via its 2021-2027 budget.

This could “represent a major step towards better coordination of fiscal policies in the region and, most importantly, a new source of highly rated euro debt for global investors,” said Goldman Sachs strategist Zach Pandl in a note to clients. last month.

Pandl has said it expects the euro to appreciate gradually against the dollar, but faster movement is in the cards. “The recent news on the euro area has taken a clearly positive direction,” he wrote.

The United States has a long list of blue chip companies that are unlikely to fall out of favor. But European assets are getting closer as conditions in the region improve, which could stimulate demand for money in the region.

A Bank of America survey of fund managers released on Tuesday found a “big leap” in European stocks. More than 40% of those questioned said they wanted more exposure to the euro.

Few alternatives, for now

There are reasons to be careful. The decline of the US dollar has been predicted many times, and it has always been premature.

The dollar benefits from being the currency of choice for many global transactions, including trading in commodities like petroleum. It represents 62% of the world’s currency reserves and is involved in 88% of all global currency exchanges. This is unlikely to change dramatically in the short or medium term.

“I don’t think we’re at the point where the dollar will lose its appeal,” said Jane Foley, chief monetary officer for Rabobank.

She noted that because the dollar tends to strengthen when the global outlook deteriorates, problems with the United States, the world’s largest economy, could actually fuel demand for money.

But over time, concerns over US debt, a weak economy and greater cohesion in Europe may begin to undermine the currency, said Nomura. The bank says the dollar could lose up to 20% of its value over the next five years.

This trend could be exacerbated by geopolitics. If Trump wins a second term, Nomura believes a continued push toward de-globalization could undermine the US dollar and encourage greater use of the Chinese yuan or renminbi, to settle trades.

Research supports the idea that an “America First” philosophy could hurt the dollar in the long run. A working paper released by the National Bureau of Economic Research in 2017 found that foreign demand for dollars could wane if the country was no longer seen as ensuring the security of its allies, causing them to hold more of their reserves in euros, yen and renminbi.

Foley noted that Russia and China are increasingly avoiding the dollar when settling crude oil deals and that after the United States withdrew from the Iranian nuclear deal, senior officials from the EU started lobbying for greater use of the euro. Companies that have continued to operate in Iran feared that the Trump administration would implement sanctions that blocked their access to the dollar.

Then there is the rise of digital currencies, which could also erode the sovereignty of the dollar. Facebook (FB) continues its Libra project, while the central bank of China is testing a digital version of the renminbi.

Huge regulatory hurdles remain due to concerns about fraud and financial crime. But Nomura said he was particularly focused on efforts in China, where the desire to increase global use of the renminbi is strong.

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