The Dollar Trade Gets Complicated
It’s been a good 12 months for the greenback. Since June 2014, the dollar’s trade-weighted value has risen some 17 percent. Both the Bank of Japan and the European Central Bank have announced new monetary stimulus within the last year, with Japan adding to existing asset purchases in October 2014 and the European Central Bank introducing a brand-new bond-buying program in January 2015. Investors who took positions that anticipated the dollar appreciating against the yen and/or the euro have profited handsomely. But now, Credit Suisse currency strategists say, the strong dollar trade will be better achieved with emerging-market currencies and/or developed economies that depend heavily on commodity exports on the other side of the trade.
Thanks in large part to the likelihood of rising interest rates in the U.S., Credit Suisse forecasts that the dollar will appreciate against both emerging-market currencies and those in the G10 (the euro, Canadian dollar, pound, Australian dollar, and Japanese yen) over the next three to six months. The Federal Reserve’s Federal Open Market Committee recently reaffirmed that the first increase in benchmark interest rates will likely occur before the end of the year, and Credit Suisse believes there will be a hike in September.
But the strategists think that we’ve likely already seen the most dramatic currency-depressing effects of central bank intervention in Europe and Japan. The European Central Bank just began its quantitative easing program in March, and it’s unlikely that central bankers will announce additional easing measures any time soon, especially since the existing program appears to be working. Private-sector consumption in the EU has been steadily ticking up, with year-over-year growth rising from 1.0 percent in the third quarter of 2014 to 1.5 percent in the fourth and 1.7 percent in the first quarter of 2015. As for Japan, Credit Suisse economists Hiromichi Shirakawa and Takashi Shiono think that with rising food prices nudging overall inflation expectations higher, it’s unlikely that the central bank will add to its existing stimulus before year-end.
For investors looking to get the most upside out of a strong dollar trade, Credit Suisse suggests that emerging market currencies are likely to see some of the most dramatic shifts against the greenback in the coming months. Rising rates—or even the threat of them—tend to make life difficult for emerging market economies, particularly those with high current account deficits. Those countries depend on capital inflows to fund their operations, and when rates are low in the United States, as they have been for the past six years, investors are usually happy to oblige. But when rates are rising, investors start shifting their money back to the relative safety of the United States. The South African rand, Brazilian real, Mexican peso, and Turkish lira look particularly vulnerable to capital outflows this time around, the strategists say.
Developed economies that lean heavily on commodities are also poised to see their currencies sink against the dollar. Antipodean central banks, in particular, have been cutting interest rates in an effort to jumpstart their economies. As a result, the Australian dollar is down some 5 percent year to date against the dollar, while the New Zealand dollar is down 12 percent. With no sign of a dramatic turnaround in Chinese growth on the horizon, they will likely ease even further.
The Reserve Bank of New Zealand cut interest rates by 0.25 percent in June, in large part due a sharp decline in dairy prices. New Zealand, the world’s largest dairy producer, has suffered as American producers have increased output and an economic slowdown in China has reduced demand for dairy imports. The central bank is considering cutting rates again in July if dairy prices don’t improve. Australia, too, has been struggling with lower commodity prices, as sluggish Chinese demand has slashed the value of the iron ore produced by Australian mines. After the unemployment rate reached a 12-year high of 6.3 percent in January 2015, the Australian central bank cut interest rates in February and March. Further cuts are possible.
The big question mark hanging over currency markets—and all other markets, for that matter—is Greece. Negotiations have stalled ahead of a deadline for Greece to repay a $2 billion loan from the International Monetary Fund at the end of June. But Credit Suisse points out that its dollar strategy should also work out well if markets swing sharply into risk-off mode. When market risk rises and liquidity thins, the dollar tends to do well against emerging market and commodity currencies.
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