The US dollar is the most unstable and unsustainable element of the financial market right now.
Various financial institutions and brokerages have mixed views about its future direction.
The US Dollar Index, a measure of its relative strength against other major currencies, rallied six months after the Federal Reserve tapering of its bond-buying program.
It rose to 100.39 in the first quarter last year from a low of 80. The index has hovered around 94-100.
That means the index has been consolidating at the high end for more than a year.
The greenback slipped after the Fed raised interest rates last year, ending nearly eight years of easy credit.
Fed chairman Janet Yellen’s recent dovish comments about the direction of interest rates have further weakened the currency.
The market is speculating that finance ministers and central bank governors reached some sort of agreement during the G20 meeting in Shanghai last month.
I think the speculation is groundless.
There are three main reasons the US dollar has fallen considerably in recent months.
First, global equity and commodity prices have rebounded.
Various indicators have been oversold. The US dollar has a negative correlation with many commodities and some stock benchmarks.
Second, the US dollar has seen the most crowded trading because most investors, including retail investors, are bullish about its strength.
Nevertheless, net long positions and risk reversal in the dollar index have started to fall off record highs.
Third, many market participants have been urging the Fed to hold or dial back rate hikes but the Fed has indicated four increases this year.
Various economic figures point to solid economic growth and rising inflation in the US in the first quarter.
That has convinced some market participants to recognize the Fed’s pace in hiking rates. The Fed might even be behind the curve.
Yellen’s surprise switch to a dovish stance has prompted investors to sell the US dollar.
The future trend of the dollar largely hinges on when the the Fed will launch another stimulus and whether emerging economies will come out of the woods.
Movement in the US dollar, euro and Japanese yen is closely linked to the balance sheet of their central banks.
The Fed is expected to stay on the opposite side vis a vis the yen and the euro as long as it holds back further monetary easing.
The dollar may not weaken substantially after all.
Meanwhile, global outstanding bank loans were US$100 trillion as of June last year, up US$27 trillion from the end of 2008.
A big portion has flowed into emerging markets in Asia and Latin America.
Many emerging markets will continue to struggle amid lackluster demand for metals and oil.
It’s likely that massive capital will flow back to the US rather than return to emerging markets.
This article appeared in the Hong Kong Economic Journal on April 7.
Translation by Julie Zhu
[Chinese version 中文版]
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