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The greenback has struggled over the past couple of weeks, as US long-term bond yields have fallen back after their surge in Q1 and risky assets generally have rallied. So it seems a stretch to attribute Monday’s further drop in the greenback to the publication of the Treasury’s report on Friday. Economists at Capital Economics believe the continued policy divergence is likely to support the US dollar.

The domestic policy mix that the US is currently pursuing will result in a stronger dollar

“Although the US Treasury’s biannual report refrained from explicitly naming any country a ‘currency manipulator’, it highlighted the growing policy divergence between the US and other major economies. We think that this policy gap will continue to put upward pressure on the US dollar – despite its recent weakness, we think that it will end the year stronger against most other currencies.”

“We expect that US yields will eventually resume their rise, and again outpace those of most other major economies. That would put renewed upward pressure on the dollar.”

“The US has implemented a massive short-term fiscal stimulus package this year, and further measures focused on longer-term infrastructure projects may follow later in 2021. At the same time, its rapid vaccination program means that its economy is reopening quickly. By contrast, policymakers in Europe and Asia have been less aggressive. This means that the US economy will probably grow significantly faster than most others in the near term.”

“In the longer term, the US’ enduring trade deficits (and the continual deterioration of its external balance sheet that results) point to a weaker dollar. But in the near term, the US’ forceful fiscal approach and resulting upward pressure on long-term US Treasury yields suggest, in our view, that the greenback will strengthen.”