Nothing can confirm that the dollar will continue to weaken, but there is considerable ‘certainty’ that US interest rates are going to fall, possibly quite rapidly.

When I was a young buck, there was a popular dancing song by Chubby Checker called Limbo Rock; two people would hold a rod across the dance floor and the dancers would have to bend backwards and slither under the rod, while everyone would shout: “How low can you go?” And with each turn, the rod would be pushed lower still—how low can you go?

Watching the dollar this past week took me back to that wild, back-breaking dance.

The dollar index has fallen by more than 11% in the past year, but in historic terms, DXY is still extremely strong. Since 2019, it has been higher than the current level (101.5) nearly 40% of the time; however, since 2015, it has been stronger just 23% of the time; and since 2002, DXY has been above 101.5 not even 15% of the time.

In other words, its long-term average level (90.5 since 2002) is much lower than today’s value. Perhaps more relevant in terms of timing, the accompanying graphic shows that DXY has fallen below a reasonably strong support and it would seem that it may well test (and possible break) the 100 level, after which the next support is around 95-96.

While none of this definitely confirms that the dollar is going to continue to weaken (and stay weak) — markets never give you such easy signals — the reality is that there appears to be considerable “certainty” that US interest rates are going to fall, possibly quite rapidly. With US employment looking a little shaky and inflation appearing to stabilise near acceptable levels, the market — always quick on the draw — is looking for as many as three cuts in the balance of 2024 and a total of 1.75-2% of cuts through 2025.

Contrariwise, the European Central Bank, while likely to cut rates at least once more this year, is nowhere near as enthusiastic, since growth in the Eurozone appears to be holding reasonably steady and inflation, too, appears to be in control. The Bank of Japan, on the other hand, has already raised rates once this year, which led to the dramatic unwinding of the yen carry trade and the nearly 5% decline in the DXY as a result. Thus, from an interest differential standpoint, the dollar appears to have nowhere to go but down.

Additionally, with the US presidential election heating up, it is becoming clear that both sides — Trump explicitly, Harris less so — would likely be happy with a weaker dollar and will design policies pushing in that direction. And, of course, in the (hopeful) event of a Harris victory, there is the real possibility that Trump’s rabble may generate some chaos on the streets, which would take at least a few basis points off the dollar’s vaunted safe haven status — I note that gold is hovering around its all-time high.

And finally, there is the elephant in the room — the US debt/GDP ratio, which is among the highest in the world, topped only by Japan, Lebanon, Singapore, and Sudan. Japan has been at the top in this regard for decades, but the fact that the vast majority of the debt is held onshore by citizens who, as a friend who lived in Japan for 25 years described it, are members of Club Japan — members will never break the rules or do anything to destabilise the club. Singapore has a huge gross debt, but it has assets exceeding its debt and so remains rated AAA. Lebanon and Sudan are economic basket cases.

The US has, of course, always lived beyond its means, and has been using the credibility generated by its deep and liquid financial markets to sustain its lifestyle. And while this has worked thus far, the weaponising of the Society for Worldwide Interbank Financial Telecommunication to implement sanctions against Russia has started to see more and more countries begin to put at least a few of their eggs in other baskets, including gold. Given that any new US administration would have huge difficulty in cutting spending right up front, this smouldering issue could add to the medium-term downward drift in the dollar.

Thus, a DXY range of 95-105 over the next six months in the event of a Democratic victory seems a reasonable bet.

On the other hand, however, if (heaven forbid) Trump were to win the election, it is possible that his radical and irresponsible ideas could trigger some real trauma in global investment markets, which could push the dollar lower still. I’d look for a much crazier DXY range of 85-95.

Time to practise limbo dancing.