More Dollar Weakness Coming on Reallocation Pressures: Nordea

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Photo by: U.S. Department of State (IIP Bureau).

Nordea Bank says the Dollar will fall as global investors diversify.

"US outperformance is behind us, and global investors are realising that their portfolios now have too many US assets in them. There is room for more USD weakness, but this process takes time," says a new note on the dollar outlook from the Scandinavian bank.

The call comes as the dollar trends lower again, yet market participants remain wary, noting the continued robust performance of the U.S. economy.

Last week's U.S. jobs report easily beat expectations and put markets on notice about betting against the economy. And with the economy holding out, surely the dollar will too.

However, a robust economy is not an outperforming one, and it's relative performance that drives currency movement.

"US outperformance is behind us and global investors are realising that their portfolios now has too much US assets in them. There is room for more USD weakness, but this process takes time," says a note from Nordea.

The note says:

● It becomes more clear as days go by that the investors’ trust in the US is weakening.
● Better prospects elsewhere could amplify the market consequence of this development.
● Even after quite a heavy USD weakening over the last year, the USD is still not very weak in a historical context.
● We have seen some fund managers calling for lower allocation to the US

Analysts explain how the exchange rate must be used as a valve to help a global rebalancing:

"As with the USD level, the level of allocation to the US is still high. The value of the US equity market makes up 50% of global equity values, while the US GDP is only 26% of global GDP.

"Let’s say that foreign investors as a group wanted to lower their allocation from 50% to 40%. As long as the US is running a deficit on their current account, foreign investors cannot sell their assets to US investors at an aggregated level. The only way this reallocation can happen is for the relative value of US assets to drop by 20%. The exchange rate is the perfect instrument for this process."

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However, analysts at Nordea's regional peer, Handelsbanken, last week released an anti-consensus view on the dollar: that it could see improved fortunes now that we're passing 'peak Trump'.

"If this idea holds, it suggests a reversal in the US market's negative momentum, leaving the question of relative performance," says Michel Gubel, an economist at Handelsbanken.

The theory goes that Trump's policy-making is a driver of USD weakness, but as his power wanes in the Republican party and he curbs his ambitions, that USD-negative impulse is blunted.

"The typical signs of a political peak are visible in declining approval ratings, legislative setbacks (including adverse Supreme Court rulings) and growing internal opposition," he adds.