In the next few weeks, we might (and it still remains a large might) see the Federal Reserve (“Fed”) finally raise rates in the US, with a 25bps rate rise pencilled in for its 15th /16th December Open Market Committee meeting. This will have implications for a wide range of asset classes, but for now, I thought it would be interesting to share our thoughts on the US Dollar.
If one looks historically, the Dollar has tended to weaken post rate hikes, as can be seen by the graph below. This is partly a function of the old adage “buy the rumour and sell the fact”, or, put differently, markets tend to price in a rate hike in advance of the event and when the actual rate happens, it is largely discounted. The question for investors today: will this time be any different? Well, we think it might be, but not for all currencies.
In terms of the majors (Euro and Yen), with the ECB and BoJ following divergent monetary policies from those of the Fed and with “Super” Mario Draghi recently upping the ante from “do what it takes”, to “doing it quickly”, it is hard to see these currencies appreciating against the Dollar as they have done in past rate rise cycles. These central bankers’ main mantra appears to be that of mercantilism or, in layman’s terms, actively attempting to talk down their currencies in order to gain a trade advantage.
When it comes to emerging market (“EM”) currencies, however, we could see some strength against the Dollar, especially for those countries running current account surpluses. From a valuation perspective, a number of EM countries have already seen large depreciations in their currencies and have attractive real yields. If history is any guide, these should have a tendency to appreciate In response to US rate hikes. We would, however, argue that commodity currencies do not fit this profile, as their countries’ trade balances remain under pressure due to weakening exports (irrespective of the weaker prices) and it does not appear that the commodity cycle has turned yet.
So, in attempting to answer the question posed in the beginning of the article, yes, we think the Dollar can continue to appreciate, but not against all currencies. For example, Goldman’s have this week highlighted the Russian Rouble and Mexican Peso as currencies that should strengthen against the Dollar, whilst the South African Rand and Chilean Peso are expected to continue struggling as the result of their reliance on commodities.
Can the Mighty Dollar Continue its Bull Run?