Is the US dollar in the middle of consolidation following a rally that started in mid-2014, or is the upward movement almost winding up? If the former case is true, how long will the consolidation last?
The pillars underpinning a strong US dollar remain intact. Since mid-2014, its rally has been mainly driven by quantitative easing (QE) moves by major central banks. The United States started tapering in early 2014 and then suspended QE.
By contrast, central banks in Europe and Japan have continued pumping money into the system. The divergence between monetary policy stances has naturally pushed up the US currency.
In the post-financial crisis era, the strength of the greenback against other major currencies has always been closely linked with the speed of expansion of central bank assets. Currently, the US has put an end to its QE, while the eurozone and Japan have gone in the opposite direction. That has set the stage for a rising US dollar.
Also, the US Federal Reserve still sticks to its stance on interest rate hike, which is widely expected by the market. The Fed is still determined to do so, although the timeline for the rate hike remains opaque. Fed vice chair Stanley Fischer has indicated that “it’s quite certain to see a rate hike within this year”.
The latest rate of Fed Fund futures shows that the market now expects a delayed rate hike as a result of recent remarks by chairwoman Janet Yellen. The current market has priced in a first rate hike late this year or January 2016. However, the longer-term futures rate continues to rise, a sign that the market still expects a rate hike sooner or later.
Meanwhile, the US economic fundamentals remain relatively solid. Market consensus anticipates a 3 percent GDP growth this year, the highest among developed economies. The US growth rate is likely to exceed that of eurozone by 1.7 percentage points, Japan by 2 percentage points and Germany, the strongest economy in the eurozone, by 1.4 percentage points.
The projected growth rates have more or less reflected market expectations. As such, the US remains the strongest developed economy, which would underpin strong the US dollar.
Lingering worries about financial turmoil would also boost safe haven demand for the US dollar. Global capital has continued to flow out of emerging markets since the US dollar switched to an appreciation mode in mid-2014.
The JP Morgan Emerging Markets Local Currency Index and the JP Morgan Asia Dollar Index have continued to slide, reflecting the capital outflow from emerging economies following the completion of the Fed’s QE3.
Meanwhile, concerns intensify that Greece will leave the eurozone. If financial turmoil occurs, the US dollar will be sought after as a safe haven.
Technical trends also support the greenback: the uptrend remains intact despite some signs of softening recently. However, it’s still too early to jump to the conclusion that the US dollar may reverse the uptrend anytime soon.
This article appeared in the Hong Kong Economic Journal on March 26.
Translation by Julie Zhu
[Chinese version 中文版]
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