For the past eight years the US dollar (USD) has been on an upward trend, rising substantially against most of its peers. Support came from three sources:
1) An improving US fiscal situation from 2010 to 2016.
2) Substantially tighter monetary policy since 2016.
3) Stronger US growth than in Europe and Japan, especially in 2011-13, and since 2017.
The first of the three sources of support for the dollar was undercut in 2017 when the US budget deficit expanded from 2.2% of GDP in 2016 to 4.7% by mid-2019. Additionally, despite recent protectionist measures, the US trade deficit has expanded, rising from 2.5% to 3.0% of GDP. This has taken the so-called “twin deficits” from 4.7% to 7.7% of GDP.
For the past three decades smaller twin deficits have usually been followed by a stronger USD – often with a lag of 1 to 2 years. Meanwhile, expanding deficits have often been followed by a much weaker USD, often with a much shorter lag (Fig.1).
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