When the coronavirus outbreak became global, the dollar first strengthened thanks to its safe-haven status before losing about 10% of its value against the euro in the space of a few weeks. This reversal of trend is partly due to the relative deterioration of both the health and economic outlook in the United States. While strict containment measures have helped in Europe to slow the spread of the virus, unclear, even contradictory, strategies from one American state to another have given the feeling of a chaotic management of the health crisis against a backdrop of a sharp and rapid increase in infections in the United States. The massive job losses and the explosion of unemployment across the Atlantic have also contrasted with the European situation where short-time working schemes have made it possible to preserve employment and skills in companies.

Finally, with the announcement of an ambitious recovery plan, financed by a common debt, Europe has risen to the challenge, enough to restore confidence in the project of European integration. In other words, the beliefs that guide the markets have given, on the basis of this objective information, a relative advantage to the euro at the expense of the dollar, at least until recently. Indeed, since the start of the school year, the resurgence of the epidemic in Europe and the rebound in employment in the United States have tempered this observation and could promote a rebalancing in favor of the greenback.

At the same time, the large monetary policy gap has narrowed in the crisis. In the world before, the US Federal Reserve (Fed) had temporarily paused the normalization of its monetary policy that began at the end of 2015, where the European Central Bank (ECB) was still in the easing phase at an admittedly slower pace, hence yield spreads that are still very favourable to the greenback. Faced with the shock wave of the health crisis on the markets, the massive easing movement on both sides of the Atlantic has converged the stance of monetary policies. The key rates of the Fed and the ECB are now at the floor and the two major central banks have flooded the markets with liquidity with asset purchase programs of a historic amount, all contributing to the reduction of the interest rate differential between currencies.

In addition, Jerome Powell, the head of the Fed, recently announced a strategic shift in the conduct of US monetary policy with a priority given to employment and greater tolerance for inflation. Instead of targeting inflation at 2%, the Fed will now seek to reach an average inflation level of 2% over time, enough to remain impassive in the face of an acceleration in prices after a period of inflation that is too low. This new doctrine of medium inflation targeting, synonymous with low interest rates for a longer period of time, has increased the downward pressure on the dollar while embarrassing the ECB still committed to its exclusive mandate of nominal anchoring.

In any case, this cyclical weakness of the dollar is not worrying at this stage since it follows a long period of appreciation and knowing that the equilibrium level of the euro-dollar exchange rate, estimated at around 1.25, still leaves room for decline. However, for some, this decline in the greenback could be of a more structural nature by being symptomatic of the weakening of the United States on the international scene. Ordinarily, the world's reserve currency is the responsibility of a state that agrees to play a benevolent leadership role capable of providing global public goods, such as liquidity and the stability of the international monetary system, without seeking to divert them to its own benefit.

However, Donald Trump's isolationist policy, the lasting hegemonic confrontation between China and the United States, the American protectionist turn, as well as the instrumentalization of the dollar for geopolitical purposes with the imposition of extraterritorial sanctions, could ultimately erode the international status of the dollar.

Yet it seems difficult to replace something with nothing. In the absence of an alternative, the dollar remains the most widely used currency for measuring prices, preserving the value of savings and regulating trade. The dollar still stands out as the billing currency of world trade; central bank foreign exchange reserves are still mostly invested in US Treasuries; the swift international payment system, in theory diplomatically neutral, remains under American influence with a dollar reigning supreme. Finally, the depth and liquidity of US markets are second to none, hence their attractiveness to investors around the world. Even though history reminds us that key currencies are deadly, the dollar king is not likely to be dethroned anytime soon.

By Isabelle Job Bazille, Director of Economic Studies at Crédit Agricole SA

In the absence of an alternative, the dollar remains the most widely used currency for measuring prices, preserving the value of savings and regulating trade.