The Dollar: How High is Up?

Mid Week Bond Update

The Dollar: How High is Up?

The greenback's move is best understood in the context of the past five years; some troubled EM countries are taking positive steps; Italy's leadership appears to have committed to meeting EU budget guidelines.

The greenback has been blamed for some of the recent uncertainty in markets, based on its rise against most other currencies since the beginning of April. But a closer look at its moves against a trade-weighted basket of currencies suggests the case may be somewhat exaggerated.

First, the dollar’s move since Q2 wasn’t exactly meteoric – some 9.3 percentage points between mid-April and mid-August. That’s small potatoes when viewed in the context of the past five years; compare it to the 25 percentage point run-up between May 2014 – March 2015 as the European Central Bank (ECB) lowered its reference rate to zero while the Fed left its target rate unchanged at 0.25%, or to the post-election slump of some 18% between December 2017 and February 2018, as the Fed raised its target rate three times. In fact, over the full 5-year period between September 5, 2013 and September 4, 2018, the buck rose just under 15.5 percent.

 

Second, the linkage between the dollar and the Fed’s program to return to a more normal range of U.S. rates hardly appears direct. To the degree there has been linkage this year, it didn’t surface until after the Fed’s March 21 decision to raise its target rate upper bound to 1.75% and then to 2.0% on June 13th – after which the dollar appeared to be range-bound. This is particularly noteworthy given the growth in rate differentials between Europe and the U.S. over the period; the ECB left its reference rate at 0.0% starting in March 2016, as the Fed brought its rate up to 2.0%, starting in December 2015. 

 

Source: Bloomberg, September 5, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

On the Rise: Some Positive Policy Moves in EM Economies  

Policy reactions have been as varied as the economies experiencing the EM currency slumps. But among the eight worst-performing EM currencies over the past five days, some important positive steps have been taken:

·       Indonesia: Central bank taking rapid measures to stave off speculators, including four rate hikes in 2018, tools for corporations to hedge dollar/rupiah risk. Economy doing ok, other than attacks on the currency

·       Mexico: Trade deal with the U.S. in progress.

·       Turkey: Central bank decisions due next week, with promises of appropriate measures being made.

·       Argentina: Pre-emptive austerity measures include elimination of multiple government ministries; continuing meetings with IMF this week on additional aid and terms.

 

Worst Performing EM Currencies, 8/25/18 - 9/5/2018

 

Source: Bloomberg, September 5, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

On the Slide:  Budget tension in Italy

Deputy Prime Minister Matteo Salvini suggested his coalition’s upcoming budget would conform to EU budgetary constraints, saying to reporters, “We can make this country grow and make Italians better off without irritating those who watch us from on high”, adding, “we will try to be good and convincing”.

Italian bonds responded positively, with 5-year sovereign yields moving down from a high of 2.587% to a low of 2.236% between September 3 and 4, a drop of just over 35 basis points – a notable improvement. However, there’s still plenty of time for the budget process to surprise to the downside before negotiations conclude and a budget is enacted.

 


All data Source: Bloomberg as of September 5, 2018, unless otherwise specified.

 

Definitions:

Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.

The DXY Dollar Index measures the value of the U.S. dollar relative to the exchange rates of six major world currencies (the euro, Japanese yen, Canadian dollar, British pound, Swedish krona and Swiss franc) which represent a majority of its most significant trading partners.

 

 

 

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