While the conventional thinking is that when the Federal Reserve does finally raise rates this will further strengthen the dollar, fixed income and currency portfolio manager Ugo Lancioni says this is not necessarily the case.
“The dollar has been on a tear recently, appreciating against a basket of major currencies by about 10% since the beginning of 2015 and about 25% over the past 12 months,” he said. “Considering that the long-term average volatility of the dollar index is about 7%, annualized, this is a major move.”
Lancioni said he has looked at the four major tightening cycles that have occurred over the past 30 years, from the end of the Volcker era to Alan Greenspan’s last rate increases in 2004-06 to try and understand how the dollar will react when the rate rises this time around.
The data from these period shows that rather than appreciating, the dollar generally declined after the beginning of rate tightening, because the bulk of the appreciation was in anticipation of rate increases rather than a reaction to them.
“Based on the assumption that the Fed will begin rate hikes in June, we plotted the dollar’s recent movements against its average level during previous periods before tightening,” Lancioni said. The dollar’s upward shift has been particularly intense—far outstripping past gains in analogous timeframes.”
“For our part, we believe that the fundamental drivers behind dollar strength are still in place. However, we can’t but feel that the current move is overdone—and suggests the need for caution on the dollar moving forward.”