Is the U.S. dollar entering a new multiyear bear cycle, or is it just experiencing an episode of weakness in an already decade-long bull run? It’s a question at the top of investors’ minds given the dollar’s steady decline since the outbreak of COVID-19 earlier this year.

Dollar cycles typically last for many years. Shifts between bull and bear cycles tend to develop very slowly, and there are often false starts. While it is too early to conclude that the dollar has entered a new bear cycle, there are notable trends that may lead it there. The year 2020 may be recognised in hindsight as a tipping point for the greenback.

Bull cycles usually reflect a confluence of unique factors that buoy the dollar. Once those factors dissipate, the dollar tends to revert to fair value. In the early 1980s, a combination of high real interest rates, tax cuts and deregulation all attracted inflows to the U.S. dollar, sending it higher. Through the 1990s and into the early 2000s, America’s stable fiscal policy and economic growth supported the dollar, while the dot-com boom supercharged the rally. In the most recent bull cycle that began in 2011, comparatively high real interest rates, an attractive carry trade and easy fiscal policy that created a relative growth advantage for the U.S. all fuelled the dollar’s appreciation against most other currencies.

A roller-coaster ride for the dollar

U.S. dollar bull and bear cycles since 1970 

Source: J.P. Morgan. As of August 1, 2020.

Now we may be at a new inflection point. Recent fiscal and monetary policy changes in response to the economic fallout of the COVID-19 pandemic, coupled with growing economic policy uncertainty, could lead to a new bear cycle. Specifically, there are three significant trends to watch: the convergence of monetary policy among advanced economies; the ballooning U.S. federal budget deficit; and fundamental shifts in global trade flows.

1. Real yield convergence reduces dollar’s appeal 

The Federal Reserve’s massive monetary stimulus and interest rate cuts in response to the COVID-19 outbreak are driving much of the concern around a potential bear cycle for the dollar. These moves have diminished a key support for the dollar by sharply narrowing U.S. government bonds’ real yield advantage over government bonds issued in other advanced economies. Attractive inflation-adjusted U.S. yields relative to those in Germany, Japan and the U.K. had fuelled a stronger dollar from 2013 onwards. The effect was amplified in 2015 when the US Federal Reserve launched a three-year cycle of interest rate increases, spurring a unique carry advantage for the U.S. dollar.