They are also looking at the US and, despite the unexpected success of the vaccines rollout – nearly 150 million Americans have received at least one dose and more than 100 million have been fully vaccinated – and a sharper-than-anticipated economic recovery, they don’t like what they see.

While the Fed should shoulder much of the responsibility for US dollar weakness (and might be happy to accept it, given it enhances US export competitiveness) it isn’t the only factor in dollar depreciation.

The RBA has made it clear that it is concerned about US dollar weakness and its implications for Australia’s export competitiveness and the deflationary effects of Australian dollar strength on the economy.

The RBA has made it clear that it is concerned about US dollar weakness and its implications for Australia’s export competitiveness and the deflationary effects of Australian dollar strength on the economy.Credit:Louis Douvis

Certainly, negative real interest rates in the context of increased inflation, and the Fed’s continual restatement of its plan to remain solidly behind the inflation curve, are part of the explanation.

The Fed has nearly doubled its balance sheet in response to the pandemic – it has swollen from $US4.2 trillion to $US7.7 trillion ($5.4 trillion-$9.9 trillion) – and is still growing at $US120 billion a month, pumping US dollar liquidity into the US and global financial systems.

There’s probably at least a year and $US1.5 trillion, if not more, of further Fed bond and mortgage purchases to come unless the Fed is forced into a change of policy stances by a sustained and threatening burst of inflation.

The other big factor at play is the massive blowouts in US debt and deficits and in the US trade deficit. Since the outbreak of the pandemic the US has enacted or announced nearly $US9 trillion of spending, about $US6 trillion of it by the Biden administration. The US trade deficit is at record levels.

If the rest of the world does experience the economic rebound from the pandemic that markets are pricing in it will create a “risk on” environment where capital flows away from the US and towards higher-risk but higher-growth environments.

On Monday the US Treasury released its estimates for its remaining borrowing program this year, which included the need to fund the administration’s latest $US1.9 trillion “relief” package. It expects to borrow $US463 billion this quarter and $US1.3 trillion in the second half of the year.

There is going to be a surge in the supply of Treasury bonds this year and into the future, particularly if Biden can get his proposed $US2.3 trillion infrastructure package through Congress.

Will there be sufficient demand to absorb that supply without a market-induced rise in US rates?

If the rest of the world does experience the economic rebound from the pandemic that markets are pricing in it will create a “risk on” environment where capital flows away from the US and towards higher-risk but higher-growth environments.

The Australian dollar, seen as providing a relatively safe exposure to China and commodities (which benefit from a lower dollar and increased appetites for risk) appreciates during those periods.

China and Russia are among the countries trying to reduce their exposure to the US dollar by trading in their own currencies.

China and Russia are among the countries trying to reduce their exposure to the US dollar by trading in their own currencies. Credit:AP

Demand might also be affected by the weaponisation of the US dollar during the Trump administration and the continued deployment of dollar-based sanctions in the early months of its successor.

There has been a long-term decline in the US dollar holdings of global foreign exchange reserves. Where central banks held more than 70 per cent of their reserves in US dollars at the start of this century that proportion has now fallen below 60 per cent and its lowest levels in a quarter of a century, with an acceleration over the past few years. The final quarter of Trump’s administration saw it drop 1.5 percentage points.

Some of that decline relates to China’s intensifying efforts to internationalise the yuan, although it still represents only a fraction of the $US12 trillion or so of central bank foreign currency reserves.

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Russia, which like China has been subjected to a raft of US sanctions, has also reduced its exposure to the US dollar and the two countries are conducting an increasing proportion of their trade in their own currencies and encouraging other countries to trade in yuan and roubles.

The European Union has always had ambitions for the euro and the creation of a fund in response to the pandemic that will issue collective debt for the first time is a major step towards the long-term goal of an elevation of the euro into something more akin to a reserve currency.

There are, therefore, some underlying structural influences that could point to a weaker dollar in the longer term (and a stronger Australian dollar), overlaid by the larger and more immediate impacts of the massive surge in supply in response to the pandemic and the prospect of even more trillions of dollars being pumped into the global system over the next few years unless the Fed reverses course and/or Biden’s spending spree is thwarted by Congress.

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