Is it time to buy the dollar? After a 10+% decline in the DXY Index so far this year, it is tempting to think so, and it is something that’s been the subject of discussion among the members of our investment committee during recent weeks.
It is probably fair to say that some of the most challenging conversations I have had with clients over my 33 years in asset management have related to currencies. In theory, given the steady and extensive stream of economic data releases and the fact that they are the deepest, most heavily traded and liquid of all markets, currencies should be one of the easier things to forecast in our world. In practice, however, to borrow the famous Ben Graham quote: whilst over the long term the foreign exchanges are a weighing machine, in the short term, they are a voting machine. And that means that forex movements are as difficult to call, and can cause an asset manager look as much of a chump, as any other asset class.
DXY Chart (Rolling 1-Yr)
Though the dominant players in the currency markets have changed, ‘twas ever thus. Not long before we met, my good lady wife was a forex trader in ANZ Bank’s corporate dealing room in Melbourne – at the time (the mid-1980s) possibly the largest such operation outside of Tokyo in the Far East region. Back then, Central Banks were the apex predators of the currency world and frequently intervened directly on both sides of the market when they perceived that speculators’ activity had got out of hand and they needed to be taught a lesson. As “SuperWife” tells it, a mere click on the Bank of Japan’s direct (key & lamp!) telephone line to her dealing room was enough to send every trader into panic mode and cut whatever yen position they were holding at the time.
Without question, that particular time represented the zenith of Central Bank influence over currencies in the floating exchange rate era. The end of their hegemony was effectively signalled in September 1992, when market participants thwarted the Bank of England’s efforts to keep the pound in the Exchange Rate Mechanism. Subsequent to that, the Mexican currency crisis of 1994 and the Asian crisis of 1997 confirmed the change in market leadership.
Since then, rising investor capital flows, the growing trend in globalisation, loosening of regulation (including exchange controls), and increasing use of leverage and derivatives have shifted the dynamic even further in favour of the market “vigilantes”. So much so that, save for the occasional isolated incident, usually involving an Emerging Market, Central Banks have largely abandoned direct forex intervention as a means of influencing their currencies’ movements.
All of which is a roundabout way of saying that, while the dollar may look fundamentally attractive at current levels from a sterling or euro perspective, any meaningful move out of a portfolio’s base currency can often require levels of patience and/or intestinal fortitude that are beyond most investor’s (and our) comfort zone. For the time being, therefore, as significant as the Greenback’s decline has been, it has not yet reached the “no brainer” levels that make us inclined to act.The currency conundrum - Is it time to buy the dollar?