STRONG DOLLAR: A BOON OR A BANE?

Such a strong rally of the dollar index in the past 12 months had not been seen since 1985. One of the main drivers fuelling such a stellar performance has been the expectation of the first interest rate rise in nearly a decade by the Federal Reserve. In fact, many are those who argue that this currency bull-run is not being underpinned by positive structural US Economic shifts and growth (that did characterise the previous ones) and is indeed due to central banks policy divergence around the globe.

Source: (ft.com)

  • Boons

– The strong Dollar has been weighting heavily on commodity prices on the one hand. This was particularly true for Gold Havens which are among those mostly hit by the dollar ascendancy (down 39% since August 2011).

“As long as the US economy remains strong enough to handle those rate hikes and as long as the Fed is going to do it gradually, gold will be under pressure as both the US dollar and rates move up”

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– On the other hand, it has also made imported goods relatively cheaper for US consumers (which should help hold inflation in check, although warning signs have yet to be detected). But it also effectively transfers demand from the US economy to those around the world, benefitting from export boost, perhaps even leading to a more balanced global economy.

These factors should boost the economy over time, paving the way for rate hikes.

  • Banes

– This strong dollar has been putting some pressure on US multinational companies who have been revising their international earnings estimates downward for the next six months (in fact, a higher dollar represents a revenue drag since it cuts the dollar value of international revenues and almost 47% of total sales from S&P500 companies come from abroad).

[keep in mind: If not hedged, this can also have a great negative impact on international investment returns.]

– In addition to cheaper oil, the strong dollar also further restrains inflation prospects (confirmed by the ever lower US Treasury bond yields) thereby additionally hindering US growth.

– Furthermore, a persistence in the greenback’s rally could be detrimental to Emerging Market corporations which have their US dollar based debt at its highest level since the late 1990s.

[Here is a portfolio repositioning idea by Allianz Chief Economic advisor, Mohamed El-Erian: ]

“The emerging market segment of portfolios would be repositioned in favour of countries with high international reserves and limited dollar-denominated debt.”

– And despite theoretically reflecting the strength of the US economy, the US dollar surge is also weighing down on the country’s Exports (as these become relatively more expensive for the rest of the world).

“Managers of so-called macro hedge funds — those that make bets across currencies and interest rates based on the direction of the global economy — have gone from cursing central banks to celebrating their diverging policies, which have opened up the chance to profit from big investment shifts across the world.”

Of course, some are those who argue that rather than a mere dollar strength, this environment could also be the result of an on-going euro weakness. A mixture of both nurtures parity talks.

This intensifies the debate among Fed officials as to whether the tightening policy process should start as early as this year and Yellen is right in dropping the “patient” stance.

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Stay tuned dear Storm-Troopers !

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