The US dollar has surged over the past month, more than erasing the losses recorded over the first quarter of the year. With many global central banks still yet to begin major monetary policy normalisation, will the Federal Reserve’s hiking cycle lead to further gains for the dollar? Investors react below:
Ugo Lancioni, head of global currency at Neuberger Berman
Since mid-April, the US dollar has appreciated sharply against both developed market and emerging market currencies. In our view, two factors explain the appreciation. Firstly, we consider the recent appreciation in the US dollar to be a correction to recouple fixed income pricing and currency pricing. The dislocation came from investors focussing on improving European data and the twin US deficit, and partially ignoring the dislocation between interest rate differentials and currency market pricing that was building up.
More recently, as European data softened, investor attention turned to this dislocation between currency market pricing and interest rate differentials, and led the US dollar to correct higher. Secondly, the available evidence suggests market participants, especially the short-term community, had been underweight the dollar, with many getting caught on the wrong side as the dollar started appreciating, causing a liquidation of underweight positioning.
Looking ahead, our view is the 1.15 to 1.25 EUR/USD range will continue to hold. Higher yields are supportive of further dollar appreciation; however, the US twin deficit and higher energy prices are dollar negative dynamics which, while having less focus at present, have not gone away. With this in mind, at current levels we are neutral on the US dollar over the medium term and instead favour a more short-term tactical approach.
Witold Bahrke, senior macro strategist at Nordea Asset Management
The US dollar should strengthen further towards year-end. First, inflation divergence is here to stay. Chinese inflation, in particular, has room to fall further. Also, it seems to us the ECB will have to tone down its tapering ambitions, weakening the euro.
Secondly, desynchronised growth is supported by Trump’s tax cuts lifting US growth, while at the same time the eurozone is suffering from last year’s euro strength. In addition, slower Chinese credit growth is a headwind to the world’s second biggest economy. Third, although we do not expect treasury yields to rise much from here, the relative yield argument pro US dollar is unlikely to weaken. It is difficult to see the ECB taking the lid off euro rates through its bond buying when growth slows and inflation is miles away from its target.
Although we do not expect the US dollar to rocket, its revival means investors need to navigate an environment of tighter monetary conditions, driven by a double whammy of a hawkish Fed and US currency strength. This stands in sharp contrast to last year’s market environment. To be clear, the recent EM woes are all about US dollar strength, as the region is most dependent on foreign dollar liquidity.
Arno Lawrenz, global investment strategist at Ashburton Investments
Heading into April, short positions of the US dollar against G10 currencies were at seven year extremes. Once it became apparent a number of key global economic indicators were rolling over or topping out, the relative economic strength of the US counted in its favour – with the dollar appreciating by almost 5% against a basket of currencies since mid-April. Likewise, the rising US treasury yields over this period also formed a positive backdrop for the dollar.
We remain cautiously optimistic on the global economy and do not expect any weakness to be deep-rooted. In the medium to long-term, we expect stabilising growth in the rest of the world, with rising commodity prices and gradual monetary policy normalisation in a number of major economies, to provide a positive backdrop to many currencies.
The US dollar is still the beneficiary of a positive carry and short-term technical factors, such as speculative positioning, point to a mildly positive outlook. On a longer-term valuation basis though, the dollar appears expensive as a result of an extensive global dollar asset accumulation phase over the past few years. This trend has not yet reversed and points to a somewhat negative outlook in the longer term.
Michalis Ditsas, fixed income investment specialist, and Fabrizio Quirighetti, co-head of multi-asset and manager of the OYSTER Absolute Return Fund at SYZ Asset Management
We predict the dollar will weaken in the second half of the year, with a target of 1.30 against the euro by the end of 2018. However, it should be noted a trend of a weakening currency rarely develops in a straight line and correction phases, after rapid movements spurred by changing macro or central bank policy, can stimulate significant rebounds.
The Federal Reserve’s path to tighter financial conditions is now largely priced-in by the markets, while both the BoJ and ECB are still deploying QE. Moreover, as the European and Japanese economies are less advanced in their expansion cycles than the US economy, economic fundamentals point to a phase of euro – and eventually yen – strengthening against the dollar. This creates a further headwind to investor demand for US dollar-priced stocks. US President Donald Trump’s announcement of the introduction of import taxes on steel and aluminium only adds to driving down the greenback.
The cost of hedging is perhaps a less considered, but important, factor. Hedging USD risk has increased meaningfully since the last quarter of 2017, which makes investments in US treasuries by European or Japanese investors costly and makes the diversification benefit less interesting. This will continue to become less attractive when bunds – and one day Japanese government bonds – offer positive yields.