Dollar bull case? There is one, and it's compelling: McGeever

By Jamie McGeever

The U.S. dollar just notched its best week in two months, a move many would dismiss as a short-term bounce in a longer-term decline, especially with lower U.S. interest rates on the horizon. But the bull case for the tarnished greenback is surprisingly persuasive.

The 1.3% rise in the dollar's broad value last week was largely a consequence of the yen's sharp slide in response to political developments in Japan. Remove that, and the dollar's gloomy outlook has not gotten much brighter.

The Federal Reserve is cutting interest rates while most of its peers have stopped easing. Crucially, President Donald Trump and Treasury Secretary Scott Bessent have made a weaker dollar a pillar of their economic strategy to boost U.S. exports, reduce the trade deficit, and resuscitate the U.S. manufacturing base.

Add to that the 'de-dollarization' narrative, in which the world reduces its exposure to U.S. assets in response to Trump's controversial policy agenda, and you might wonder what the bullish case for the dollar looks like.

Standard Chartered's head of G10 FX research Steven Englander and team are among the few analysts calling time on the dollar decline. They predict the euro will fall to $1.12 within the year from $1.16 currently.

Their thesis rests on three interconnected premises: U.S. productivity growth will remain strong, the country will maintain its lead in the global artificial intelligence race, and real U.S. interest rates will stay relatively high.

It's a pretty compelling argument.

PRODUCTIVITY, AI FUSION

First, productivity.

The U.S. economy's dynamism and flexibility have helped it maintain a productivity advantage over many of its peers for long stretches. There are signs the lead could widen.

U.S. productivity growth in 2023 was 1.6%, according to the most recent data from the OECD, well above the OECD average of 0.6% and in stark contrast to the 0.9% fall in the euro zone that year.

Fast forward to 2025, and the trend continues. Annualized U.S. productivity rose 3.3% in the second quarter, outstripping other developed economies. Englander and colleagues reckon this could rise to 5.0% in the third quarter.

Trend productivity growth may be set to rise too, they noted, largely thanks to artificial intelligence.

While "sizeable" productivity benefits from AI have yet to be seen, according to the OECD, it is reasonable to assume that the U.S. will enjoy them disproportionately once they do emerge. They cited the country's current position in the AI race, strong intellectual capital, relatively lax regulation and flexible labor market.

The combination of rising productivity and continued AI dominance driving solid growth is an attractive one for overseas investors, yet seemingly inconsistent with Trump's wish for much lower interest rates.

"Artificially low real rates are likely to lead to overheating, especially if the economy is already running faster because of higher productivity and profitability," Standard Chartered's team wrote, adding, "we greatly doubt that the U.S. can have sustainably low real rates, a weaker dollar and strong productivity growth."

Inflation-adjusted U.S. policy rates remain high by world standards, and barring extremely aggressive interest rate cuts, that's unlikely to change soon.

CUT AND DRY? NOT SO FAST

But what about global concerns about imprudent U.S. policy and familiar cries that AI and U.S. Big Tech are the mother of all bubbles? These are valid, but not set in stone.

First, in order for capital to flow out of the U.S., it needs an attractive alternative – and investors don't have many.

Lurches towards looser fiscal policy - and potentially easier monetary policy - are not confined to the U.S., as events in Japan last week showed. The yen has slumped to a record low against the euro and is approaching its recent 30-year low against the dollar. "Debasement" worries loom large over many currencies, not just the dollar.

Then there is the AI bubble question. U.S. tech certainty looks frothy, given the surge in prices, valuations and market concentration. But relative to the internet boom in the late 1990s, this one still appears to be at an early stage. As Eurizon SLJ's Stephen Jen and Joana Freire wrote on Friday, "Dot Com Bubble 2.0: We are Only at Base Camp."

U.S. policy could get in the way: look at Trump's impulsive decision on Friday to slap an extra 100% tariff on imports from China. But recent evidence suggests Trump is unlikely to stick to his guns if markets protest.

So even though the dollar bear case remains one of the most widely held views in the global investment community, it may not be so cut and dry.

(The opinions expressed here are those of the author, a columnist for Reuters)