Wading into the debate on the timing of US monetary policy in its annual report on the state of the US economy, the IMF said at current, real levels, the dollar was moderately overvalued, a situation that could push the country’s current account deficit further away from medium-term fundamentals.
“So far, the global adjustment of exchange rates has represented a warranted shift of demand to those parts of the world economy that were being most threatened by deflation and stagnation. Nonetheless, the stronger dollar is impacting U.S. growth and job creation, as well as weighing on inflation,” it said.
Given that some of the dollar’s strength in recent months is attributable to the passing of the quantitative easing baton from the US to first Japan and then Europe, as well as how careful Fed chair, Janet Yellen, has been to try and mitigate any surprises, the IMF’s comments are unlikely to have been welcomed in Washington. Indeed, it has been argued by some economists that the US would have liked to have moved sooner, but chose not to because of the situation in Europe.
But, while the IMF’s comments are unlikely to have been welcomed in the US, it would be prudent to heed it’s warning that: “regardless of timing, higher U.S. policy rates could still result in a significant and abrupt rebalancing of international portfolios with market volatility and financial stability consequences that go well beyond U.S. borders.”
Especially when taken in concert with the ongoing negotiations in Greece and ECB chair, Mario Draghi’s comments on Wednesday that markets should “get used to volatility”.
The question for investors though is, how do you go about insulating a portfolio from such an outcome – especially when valuations across asset markets are high, and many traditional shock absorbers are looking pretty shocking?
