Bulls or Bears? What’s next for the greenback?
The USD has plunged by 4.1% in Q1 2016. This marks the currency’s largest quarterly decline in over five years, and it is largely attributed to a confluence of factors in the global market. Chief among them is the Federal Rserve decision to go slow on interest rate hikes in 2016. That Janet Yellen opted for a policy of gradual interest rate hikes over the course of 2016 has not helped the USD. The first and only rate hike in several years took place on December 16, 2015, and since then the Fed has threatened to raise interest rates if conditions in the global market and the domestic market warrant such an action.
It is an interesting set of circumstances that currency traders and economic analysts find themselves in now; the US is the world’s #1 biggest economy and the fact that the Fed is considering raising interest rates in the future is an indication that the US economy is structurally sound. The Fed’s desire to adopt quantitative tightening measures is reflective of an economy that is on track to perform well in 2016. And since the US economy is the biggest, this bodes well for the world. However, analysts caution that strong currencies are not necessarily synonymous with strong economies, with Japan being a case in point.
A strong USD has been responsible for the poor performance of commodities, given that dollar strength generates instability for the global economy. A strong USD makes it difficult for foreign buyers to purchase dollardenominated goods since it costs more. The Fed decision on March 16 to leave interest rates unchanged has done little to bolster confidence for the greenback. Various central banks around the world, such as the Reserve Bank of Australia have benefited immeasurably from the weakening USD, notably emerging market currencies. The performance of the USD is such that currency traders are uncertain about the long-term viability of the greenback.
The USD endured rallies over the past 50 years that were substantially greater than the 32% appreciation of the greenback since 2011. In the late 70s, the dollar rally began with the naming of the new Fed Chairman Volcker. It continued right through until the early 1980s when the Plaza Accord was announced. That dollar rally lasted for 67 months. Then a dollar bear market ensued right through until the mid-1990s. Rubin then opted for a strong USD policy and this resulted in a Bull Run for the dollar for 81 months. This lasted until the early 2000s. The dollar has since rebounded for the past 57 months, since 2011. The point being, the dollar rallies that have taken place over the past five decades have resulted in far sharper appreciations than the current dollar rally. But currency traders are not quite ready to pull the plug on the USD. For example, the Standard Bank Group is forecasting an appreciation of 8% to $1.05 against the euro, and as much as 12% against the JPY over the course of the next 12 months.
Participants in the forex market are uncertain whether the USD is capable of sustaining the strong gains it is made since 2011. The recent decision by the Fed has many forex traders scratching their heads about the future direction of the currency. However, not everybody shares the bearish perception of the long-term viability of the USD. The RBS Group is of the opinion that the weakness in the USD is temporary and a recovery is entirely possible. The Fed is clearly deeply concerned about the state of the global financial markets and it is for this reason that it is delaying rate hikes. The strength/weakness of the USD impacts far and wide. Many currencies are pitted against the USD, notably the Chinese renminbi. Whenever China feels that its economy is performing poorly, it will work to devalue the currency to make the Chinese economy more competitive.
In Q1 2016, the USD plunged 4.6% against the EUR, making this the worst decline in five years. The USD was at its highest level against the EUR back in 2003. In the same time, the USD slid 6.4% against the JPY. Various bankers and currency traders remain cautiously optimistic about the prospects of the USD. An important yardstick for the USD is its performance relative to other G 10 currencies. On that front, the USD is performing rather strongly. The Bloomberg US dollar index is currently 0.17% lower at 94.456. It has a year to date return of -4.23%, with a 52-week range of 92.621 on the low end and 100.510 on the high-end. Forex traders are distressed about which way to go with the USD in Q2 2016 and beyond. Some believe that the dollar has suffered a minor setback, while others believe it is a long-term reversal taking root. The DXY (US dollar index) offers a trade weighted gauge of the strength of the USD versus a basket of currencies. 2016 has been a tough year for this index, and clarity remains far off.
The Fed’s purpose appears to have shifted from being the central bank of the US to being the monetary policy guard dog of the global economy. The Fed, therefore, has to cautiously measure its decisions against what is right for the domestic economy (full employment and economic stability) and global economic conditions. The world economy is the more pressing issue for the Fed, given the Chinese economic collapse in 2015. The Fed acts in a stabilising capacity to bring balance to the global economy. In much the same fashion as the European Central Bank acts in the best interest of broader Europe, the Fed acts in the best interests of the global economy.