TD Bank economists are forecasting a 20% drop for the U.S. dollar. After years of warnings that the big U.S. current account deficit would eventually force a significant depreciation in the U.S. dollar “the process now appears to be underway,” say the economists.

The recent drop in the U.S. dollar against most other major currencies has been fueled by disappointed expectations and shifting capital flows, says TD. “While U.S. economic growth and productivity gains will continue to outpace those in most other industrialized countries, the degree of out-performance will be significantly less than in the past.”

Investors are finding that they over-invested in America during the last expansion, says TD. “The combination of these factors has led to a re-balancing of global capital flows to the detriment of the U.S. dollar.”

The dollar needs to drop by about 20% to eliminate its present overvaluation and reduce the U.S. current account deficit to a sustainable level. The most probable scenario is a gradual retreat in the greenback’s value. “The biggest run-up in the dollar and the greatest deterioration in the U.S. current account balance occurred over the last
four years, and it may take as long to unwind the imbalances.”

“Given the prevailing negative sentiment towards the greenback, there is little doubt that the U.S. dollar will continue to weaken. On a trade-weighted basis, a further 5% decline is expected by the end of this year, leaving the U.S. dollar more than 8% below its record peak in February 2002. Some currencies may consolidate their gains in 2003, limiting the decline, but not stopping the retreat, in the U.S. dollar.”