Although some observers have attributed the high volatility in global financial markets this year to issues related to China and its currency, we should not underestimate the influence of the dollar exchange rate on asset prices.
The dollar index has fallen to below the level seen in 1997 as the possibility of the Federal Reserve enacting several rate hikes in the near term becomes increasingly unlikely.
Previously it was believed that the Fed would hike rates as many as four times this year. But now the expectations are that it will raise rates only one or two times at the most, given the challenges surrounding the global economy and markets.
A strong dollar has brought pressure on emerging economies in the recent past, especially with regard to their currencies.
In the past year, most of the emerging market (EM) currencies depreciated against the dollar. Meanwhile as the media keeps telling stories about capital outflow from the EMs, their currencies have come under even more pressure, creating a vicious cycle.
The devaluation of the renminbi, plunge in oil prices, and the rout in mainland stock markets all came under the shadow of a strong dollar.
But now if traders believe the greenback has peaked out and that it will begin to weaken gradually, there will be a positive influence on non-dollar currencies.
Market reaction will tell whether the negative interest rate in Japan is a wise policy. The Japanese central bank has created a daydream. After the US dollar rose to 121 against the yen, it soon fell to below 117.
Is this because the market doesn’t believe the extended quantitative easing policy in Japan will be effective? Or is it very cautious about the outlook of the economy?
I think both make sense. If the dollar weakens, commodity prices, non-dollar currencies and stock markets will all benefit from it.
It will be hard to boost investors’ confidence in China’s A-share market only through monetary and fiscal policies, given the 20 percent slide in the mainland stock market since the beginning of 2016.
But if the dollar weakens, renminbi exchange rate will stabilize and sentiment on the mainland stock market could improve.
We should also keep watching whether the central government will launch more stimulus measures.
Gold price has quietly risen to US$1,155 per ounce. Part of the reason is the central banks’ failure in relation to inflation targets.
The US has entered the second stage of interest rate normalization, while European and Japanese central banks can only use the tool of negative interest rate.
Given the uncertainties in global financial markets, it’s no surprise that gold is being seen as a good hedging bet.
This article appeared in the Hong Kong Economic Journal on Feb. 11.
Translation by Myssie You
[Chinese version 中文版]
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