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US dollar faces its own ‘market rotation’

Gulf-based investors and earners have choice of scenarios to confront

Gulf News

Financial markets recently have suggested there is change in the air, with signs of rotation from bonds into equities, and a far better balance between risk and reward available in stocks at this juncture.

Although both asset classes benefit from the implied underwriting of key central banks, it appears the risk-on/risk-off phase may be passing, as the sense of crisis weakens. Although the European situation remains fearful, the US could be on the road to recovery, while the likes of Japan, China and India may be heading for renewed pick-up.

Still, there are undeniably plenty of ifs and buts still to be accounted for in those claims, on every front.

One important feature of the developing mood is a reappraisal of the US dollar, whose movements are losing the kneejerk reactions that have been so clearly visible since the global financial crisis struck.

Last week’s review here of nominal and real exchange rates was intended to highlight that there are potentially opposing pressures and a technical dimension to currency policy and management.

The truth remains, however, that any revised arrangements associated with proposed Gulf monetary union don’t appear to be imminent, and that therefore the fate of the dollar, to which the region is so strongly attached, is bound to retain greater attention.

Both expats and investors are naturally attuned to how their dollar-linked earnings and base investment currency are likely to fare, and would presumably like therefore to have an idea whether the dollar itself is going to behave differently from this point.

Holders of US dollars and its Gulf near-equivalents may well be concerned as to where the value of their cash is heading, and indeed that the Fed’s committed efforts will succeed in diminishing their earnings and wealth.

At the same time, they may be comforted by the thought that the dollar is evidently still the pre-eminent benchmark in times of crisis, and indeed that the GCC currencies are (presumably) only ever going to upgrade against it, for instance in the event of monetary union, whenever that might be.

Talk has grown again internationally of potential currency wars, as most of the world’s currency blocs suspect that they may respectively need competitive devaluations to generate competitiveness and growth by way of their share in international trade.

That fits nicely, as both a rationale and consequence, with the repeated efforts of central banks to keep printing money, itself both to provoke domestic activity and reduce the effective weight (when inflation ensues) of massively accumulated debt.

By historical perspective, though, it’s a nasty and damaging downward spiral in the offing.

In the week that Germany announced the intended repatriation of all its gold physically from foreign central banks, it’s difficult to blame anyone fretting about being stuck in hyper-inflating cash, and who has half a mind to buy some shiny precious metal that is worth more than the paper it isn’t written on.

In the markets, focus has been on the deliberate weakening by the incoming Japanese administration of the high yen, which has prompted voices in Europe to worry aloud about the high euro in still weak global conditions.

Tim Fox, chief economist at Emirates NBD, has laid out a working perspective of this potential turning point in the market, noting that the overall US dollar index has actually been contained within its range of the past four months, wedged between the yen’s and euro’s offsetting trends.

“On past experience rising global risk appetite has often been aligned with a weaker US dollar, but this is only a relatively recent phenomenon due to [its] position as the funding currency of choice against a background of zero interest rates and seemingly endless quantitative easing,” he explains.

Now, however, that identity “is being challenged, by the yen in particular.”

Yet, there is -- as so often -- a dichotomy about the direction ahead.

On the one hand, a strengthening US economy, with the resumption of higher bond yields, might lead to the dollar becoming a carry trade, on the other side of the equation with the yen. That’s to say the market would leverage its switch towards the dollar, enhancing the movement.

On the other hand, that same strengthening economy would surely still be integral to perceptions about what remains a stuttering world recovery, and a shift from ‘risk-off’ to ‘risk-on’ mode that would check the dollar as its safe-haven status became less relevant.

Another concern that a sceptic might mention would be that any concerted rebound in the American economy that is met by rising bond yields will by that very fact find itself constrained. Such is the weight of the accumulated burden and difficult experience of recent years that it’s easy to imagine a self-induced relapse.

Clearly, investors have to recognize that this has not been a purely cyclical experience for either the US or global economy.


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