Comment: A comeback for the greenback?

Ahead of the US Federal Reserve’s policy meeting today, Salman Ahmed, chief investment strategist at Lombard Odier Investment Managers, examines whether the US dollar could stage a comeback.

The US dollar is a worthy target for investor attention, given the key role it plays in financial markets and global trade. Following a prolonged period of depreciation, the dollar has strengthened in recent weeks. Is this the sign of a sustained shift taking hold? And should investors be concerned over a strengthening dollar?

We at Lombard Odier believe that disquiet over the direction of US trade and fiscal policy was a key driving force that pushed the dollar lower last year by reducing foreign demand for the currency and US Treasuries, alike. Moreover, the prohibitively high cost of hedging investments in US treasuries rendered the yields unattractive for foreigners, creating a double whammy effect, in our view.

With investors’ concerns now seemingly abating, and US economic growth once again appearing to outpace that of other countries, demand for both the dollar and US treasuries could see a sustained rise, especially if foreign investors become more willing to invest on an unhedged basis. Moreover, any appreciation in the dollar could be amplified by a reversal of the current large short dollar position in the market. As an appreciation of the dollar could act as a drag on global growth and push inflation higher, how concerned should investors be?

Keep a close eye
In the medium term, we believe that concerns regarding the expansionary American fiscal policy coupled with increased US Treasury issuance will continue to put downward pressure on the dollar. We would also be surprised if the US administration allowed a sustained appreciation to persist.

Dollar strengthening would benefit investors with a non-USD base currency who are invested in USD-denominated assets – such as commodities – and could also benefit European equites. However, it could be negative for emerging local currency bonds and equities. The magnitude of the impact will mainly depend on the extent of the USD appreciation vs. the relevant local currency. Investors should keep a close eye.

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