DOLLAR RISE: FURTHER TO GO OR FINISHED? / THE FINANCIAL TIMES MARKETS INSIGHT

Markets Insight

August 6, 2015 6:23 am

Dollar rise: further to go or finished?

Michael Mackenzie

Stronger dollar presents problems for many areas in financial markets

 

©Getty

 

These are propitious times for US and UK travellers lining up at airport foreign exchange booths en route to foreign climes.

 

Less enamoured are gold bugs and producers of commodities such as iron ore, oil and copper that are priced in the US currency. Also under pressure are foreign holders of dollar debt facing higher payments in the future due to their weakening domestic currencies. Then there are countries, such as China, which trade in a band against the dollar, beset by slowing economies, while seeing their trading partners bolstered by depreciating currencies.

 

Closer to home, US multinationals stand to miss out on $100bn in revenues this year due to the stronger dollar, reflecting how S&P 500 companies rely on foreign markets for nearly half of their revenues, according to S&P Dow Jones Indices.

 

A stronger dollar therefore clearly presents problems for many sectors of financial markets, and not surprisingly some fear further appreciation in the world’s reserve currency will spark greater financial turmoil, defined by debt crises for emerging market countries.

 

Therefore a pressing issue at the moment is whether the dollar has peaked or is merely in the early stages of what would be a third major bull market since the demise of the Bretton Woods era in the early 1970s. A compelling feature of the dollar’s strength during the first half of the 1980s and then in the late 1990s was how it helped spark EM debt debacles.

Pressure on EM and commodity currencies remains well entrenched at this juncture as the US Federal Reserve appears set to lift official borrowing rates for the first time in nearly a decade.

 

“EM will have to deal with the inevitable,” noted analysts at Citi this week. “Irrespective of exact timing, the US Fed will conduct some normalisation of monetary policy, which may pressurise funding costs in US dollar leveraged EM economies.”

So far this year, the dollar on a trade weighted basis has climbed some 8 per cent, after gaining 10 per cent over 2014. In the wake of patchy US economic figures during the spring, the dollar has lately reversed much of its swoon that occurred after hitting its highest level since 2003 back in March.
 
Much depends on the tone of the next two monthly US employment reports, with July’s figures due on Friday. Given the degree of appreciation seen so far for the dollar, one could make a case that currency markets have essentially priced in a modest pace of Fed tightening over the coming year.
 
We may therefore be near a top for the dollar in trade-weighted terms and set for a period of less downward pressure on commodities and US multinational revenues once the Fed starts its new tightening cycle and stresses a slow and measured pace.

The counter argument is that there appears little resistance, with both the dollar and sterling harnessing a strengthening tailwind as their respective central banks inch towards shifting borrowing rates higher, when many other countries are easing policy or seeking weaker currencies.

 

According to Deutsche Bank, only the Japanese yen and Norwegian krone on a trade-weighted basis have weakened further at this juncture than they did during the dollar’s previous two big bull runs.

That leaves further room for the dollar to continue rising, says the bank, which forecasts an additional gain of 10 per cent on a trade-weighted basis for the currency.

Alan Ruskin at Deutsche Bank says commodity currencies will feel further heat, while more attention will focus on dollar pegs and bands, notably that of China, given its importance within the global financial system.

“Currencies pegged to the dollar have a hard time whenever the dollar is strengthening substantially,” he says, explaining there is a risk that this eventually encourages slippage in China’s renminbi, sparking significant volatility and a round of competitive devaluations.

 

As it stands, the renminbi accounts for a weighting of between 10 and 20 per cent in most countries’ trade-weighted measures. That means further strength in the dollar, not matched by a firmer renminbi, will ripple far and wide.

 

“With China searching for ways to ease financial conditions, this is not the moment where an Rmb tagging along with US dollar gains is desirable,” says Mr Ruskin.