The strength of the dollar over the past 18 months has been remarkable. Just as remarkable, in fact, as the almost unwavering conviction from many in the market that the currency can continue on its upward path.
That, however, has changed somewhat. The movements of the past few weeks across all markets have left many asset allocators sceptical, not just about the path of the dollar but about US growth more generally. And, it would seem, while the consensus call remains for the currency to remain strong, the contrarian call is for a weaker greenback than many expect.
What is clear though is that the path of the dollar remains one of the key focal points for asset allocators in 2016.
In 2014 and 2015, the strength of the greenback was largely attributed to the improving US economy and the expectation that this would lead to monetary policy divergence as other developed markets were likely to keep their feet firmly planted on the liquidity pedal. Although this divergence finally occurred, it took a great deal longer than most expected, and when it did, in December 2015, it came against a backdrop of fairly mixed economic data.
Outside influence
As Columbia Threadneedle’s fixed-income portfolio manager Alex Batten points out, it has been continued policy easing from other developed markets and the expectation of policy tightening from the Fed that has driven the dollar bull market, rather than sustained policy divergence.
For Batten, this subtle difference implies, that at the start of 2016, the dollar looks richly valued compared with its history, and the ability of this “policy divergence” theme to continue to drive the currency higher is now limited.
“The FX market has front-run the effects of policy tightening from the Fed,” he says. “While policy divergence as a dom-inant theme in markets is not dead, its ability to push the dollar to new highs is certainly dwindling.”
Indeed, Batten adds, as the dominance of this theme diminishes, “the market may focus more on valuations and structural issues afflicting currencies, which would not lend support to the dollar. As such, we do not forecast broad-based dollar gains over the year.”
Max King, an investment strategist at Investec, is also unconvinced about the future path of the dollar. According to him, the firm’s strongest currency conviction among the major currencies this year is the yen.
“We think the yen is cheap and we find it easy to have a view that the yen is going to go up against the dollar. When it comes to dollar versus sterling or euro, however, we find the going tougher.
“Not only are we are sceptical of the dollar strength story but we do not have a strong conviction on the euro or sterling either.”
