I think one of the biggest catalysts behind the general rise of the US dollar (USD) over the last 10 years or so has been the marked improvement we have seen in the US energy trade balance.
The so-called “shale revolution” has benefited the US economy in myriad ways, from enhanced productivity to higher levels of employment and increased tax revenues. However, the degree to which it has helped to moderate the underlying deterioration in the US current-account deficit has gone largely underappreciated. That, in turn, has been a tailwind for the USD for most of the past decade. I’m just not sure how much longer this energy-driven USD strength can continue.
Energy-driven USD strength
The US was running an annual energy trade deficit of around US$400 billion back in 2008, nearly identical to the nation’s non-energy goods deficit at the time (Figure 1). Thanks to the power of unconventional oil and gas, the US became a net energy exporter by 2020, with the energy trade balance moving to an annual surplus that peaked at US$18 billion in early 2021. That US$400 billion difference (dark blue line) helped to offset the US$550 billion worsening in the non-energy trade balance (light blue line), which resulted from superior US economic growth relative to the world.
Thus, to an extent, the positive terms-of-trade dynamic emanating from the US energy sector has acted as a shock absorber for the USD, preventing the sort of blowout in the current-account deficit that would normally happen during a business cycle in which the US is leading the global recovery.
Shifting trade dynamics
The problem now is that this trade “equilibrium” appears to be breaking down on both sides of the equation.
First, the US energy balance has returned to deficit in recent months. It may be premature to call this a definitive trend change as US oil demand growth is very mature, meaning any material growth in US oil supply would likely need to be exported. Still, it seems reasonable to assume that the improvement in the US energy balance over the past decade is unlikely to be repeated, given more limited US shale reservoirs and environmental, social, and governance (ESG) frameworks having instilled more discipline among oil producers.
Meanwhile, a US import boom is underway that one of my colleagues aptly described as a spending and social tsunami, driven by: 1) exceptionally loose US monetary and fiscal policy; 2) post-COVID release of pent-up demand; and 3) accelerating consumption outstripping domestic supply, leading to greater reliance on imports. (As of March 2021, US imports were about US$17 billion higher than a year earlier.)
The important question in my mind is whether there will ultimately be consequences from today’s US policy mix in the form of ever-growing external deficits that will be difficult to fund without a much weaker USD. With US real interest rates mired at record lows, the burden will likely fall more on the USD than on US yields to entice foreign investors to help bridge the US savings shortfall.
The past 12 months have been characterized by very benign USD depreciation. Could the next 12 devolve into something less orderly that creates a negative feedback loop for both US equities and US Treasuries? A scenario of contemporaneous price declines in the USD, the S&P 500 Index, and Treasuries occurred very infrequently in the latest era of secular disinflation, but this “trifecta” might arise more often in a world where US policy credibility is eroded and inflationary forces begin to dominate. Time will tell.
- How the world saved its way to secular stagnation (March 2021)
- Is this the end of secular stagnation? (February 2021)
- Managing risk in an unconstrained fixed income strategy (September 2020)
- Opportunistic investing: 20 years, 8 lessons (September 2020)