The US dollar is down but not out: BCA

Investing.com — Despite recent weakness, analysts at BCA Research in a note dated Monday assert that the US dollar remains resilient and is expected to rebound in the coming months. 

The global economic landscape, characterized by a downturn in manufacturing and increasing caution in financial markets, sets the stage for the dollar’s recovery.

The greenback may be down, but according to BCA Research, it is far from being out of the game.

In 2024, global financial markets have seen the US dollar lose some ground as the broader economic environment has been clouded by uncertainty. 

Global manufacturing, which had briefly stabilized earlier in the year, has entered a renewed contraction phase. This relapse is accompanied by a weakness in oil and copper prices, key indicators of global economic activity. 

Additionally, various segments of global risk assets have failed to break above their previous highs, signaling deteriorating global growth conditions.

Moreover, liquidity conditions are tightening. BCA Research notes that global dollar liquidity, defined as the sum of the US monetary base and securities held in custody by the Federal Reserve for foreign officials and international accounts, is declining. 

This factor has contributed to the current decline in the dollar’s strength. However, this very dynamic of reduced liquidity could eventually prove to be a boon for the dollar.

“Notably, tightening global USD liquidity – calculated as the sum of US monetary base and securities held at the Fed for foreign officials and international accounts – is typically positive for the greenback,” the analysts said.

This tightening is tied to global manufacturing, which is closely correlated with dollar movements. As the global economy contracts, the US dollar often behaves countercyclically, appreciating as riskier assets suffer losses.

The current situation bears some resemblance to the early 2000s bear market. In the first phase of the 2000-2002 bear market, the US dollar appreciated as global equity markets, including emerging market (EM) stocks, sold off​. 

If this pattern repeats, the dollar could follow a similar trajectory in the coming months, gaining strength during the initial stages of the bear market.

One of the key reasons BCA Research remains positive on the US dollar is the structure of the global financial system.

The US dollar remains the dominant global reserve currency, with a majority of international transactions settled in dollars. 

Furthermore, in times of economic stress, investors often flock to the safety of US assets, which further supports the dollar.

“The broad trade-weighted US dollar has so far not broken below the lower end of its rising channel,” the analysts said. 

The currency still benefits from its role as a safe haven, which should sustain demand, especially as economic uncertainties persist globally.

Emerging market stocks and currencies are strongly correlated with global growth. BCA indicates that renewed contraction in global manufacturing will likely lead to a downturn in EM equities and currencies. 

A stronger US dollar could add to these pressures by making it more expensive for emerging markets to service their dollar-denominated debt, further hampering their growth prospects.