Upside Dollar Potential

June 10, 2015

The dollar is in a corrective phase.  From the low in 2014 to this year’s high, the dollar advanced 33.8% against the euro, 26.2% against the Australian dollar, 25.7% relative to the kiwi, 24.9% vis-a-vis the yen, 22.1% on a trade-weighted basis, 21.3% versus the Canadian dollar and 18.0% against sterling.  Varying percentages of these appreciations have now been reversed.  The smallest retracements in this set of bilateral dollar pairs involve the Aussie and New Zealand dollars, 10.5% and 9.3%, respectively.  The largest reversals are sterling (36.4% of the prior climb), the loonie (25.6%), and the euro (23.9%).  Retracements of the trade-weighted dollar and dollar/yen amount to 10.9% and 12.4%.

Dollar-supporting economic fundamentals remain in place.  The United States has comparatively attractive demographic metrics.  Future monetary policy changes favor the dollar, as do economic growth differentials, the Greek debt crisis, and the rebound in world oil prices. 

The dollar rose more extensively in the early 1980s and late 90s to early noughties than it during the past thirteen months.  In the early 1980s, the greenback advanced 87% in trade-weighted terms, 105% against the D-mark and 59% relative to the yen.  In the dot-com/euro launch period, cumulative dollar appreciation amounted to 49% in trade-weighted terms, 71% against the mark-translation value of the euro and 69% vis-a-vis the yen.  These historical comparisons tell us that a resumption of extensive dollar appreciation would not take currency trading into unprecedented waters.

A different and more serious constraint to a rising dollar is the strain such would put on emerging markets.  EM currencies already have declined sharply.  In the year to early June, the Russian ruble tumbled about 35% and the Brazilian real, Colombian peso and Turkish lira fell more than 20%.  The currencies  Malaysia, South Africa, Chile, and Argentina fell more than 10%.  Runs on emerging market currencies would boost inflation, raise interest rates, and depress growth in many emerging markets.  Federal Reserve officials have indicated they will not completely ignore how their rate-normalizing efforts affect other economies.

Little in foreign exchange forecasting comes close to certainty.  The dollar’s present correction makes intuitive sense.  Corrections within a longer trend are a fact of market life, and this one was encouraged by shifting growth expectations that have narrowed the differential better U.S. prospects and those in other advanced economies.  That said, the framework of fundamentals that powered the dollar’s gains from May 2014 to March/April 2015 seems intact more or less, and historical precedents show that the dollar has nowhere near approached the historically largest advances.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

Tags: , , ,


Comments are closed.