John Husselbee

All eyes on the dollar

John Husselbee

This piece originally appeared in FT Adviser on 12 March 2018.

We have often written about ignoring market noise as far as possible and in the current era of political volatility, this seems more important than ever.

Looking at 2017, we saw a series of apparently major macroeconomic events, from elections in Holland, France Germany and the UK, to blow-ups in Korea and Catalonia. While many of these caused small corrections in equities, the FTSE 100 was up 10% over the year, which stresses the importance of ignoring headlines and focusing on fundamentals.

In any case, we believe the most important factor in markets at present is the US dollar, with recent weakness potentially the main driver behind the synchronised global growth we are enjoying. If you look at emerging markets for example, many are benefitting from ongoing reform but the weakening dollar has also provided a huge trade boost and created considerable tailwinds for these countries.

There are several reasons behind the weaker dollar, with a stronger oil price tending to weigh on the currency for example. But the greenback is currently considerably weaker than might be expected and as with everything US-focused at present, the presence of President Trump looms large.

Trump helped turn a trend of dollar strength prior to his inauguration in January last year when he said the currency was too strong and US companies could not compete as a result, particularly against Chinese counterparts. Since then, the dollar index is down close to 10% and fell to a three-year low at the end of January when Treasury Secretary Steven Mnuchin, speaking in Davos, echoed Trump’s stance that a weak dollar is good for America and sparked fears of a trade war.

“The dollar is one of the most liquid markets. Where it is in the short term is not a concern for us at all. A weaker dollar is good for us as it relates to trade and opportunities. Longer term, the strength of the dollar is a reflection of the strength of the US economy and that it is, and will continue to be, the primary reserve currency,” he said.

Recent news that the US intends to impose tariffs on steel and aluminium imports have done little to alleviate trade war concerns.

Given the current stock market exuberance, this has led to speculation the US is seriously rethinking its policy towards the dollar. Back in the mid-1990s, following a period of extreme dollar weakness, Bill Clinton’s Treasury Secretary Robert Rubin argued a strong currency is in America's interest and that has been treated as accepted wisdom since.

Mnuchin’s apparent support for a weaker dollar led to a sideswipe from European Central Bank president Mario Draghi, emphasising concerns among central bankers over the impact of exchange rate swings. Draghi said that although exchange rate movements are “a fact of nature”, some recent volatility was caused by “someone else” whose “use of language...doesn’t reflect the terms of reference that have been agreed”.

He cited an IMF communique from last year, signed by the US, which said: “We will refrain from competitive devaluations, and will not target our exchange rates for competitive purposes.”

Backlash against Mnuchin has also come from the economic community, with many saying a weaker dollar makes the country worse off because people are not living in a bubble: in the simplest terms, dollar devaluation makes imports more expensive.

More recently, Mnuchin (and the President) seem to have retraced their steps slightly on this subject, unwilling to pick too hard at the idea that, in the long term, a strong currency means a strong economy.

With the rise of the renminbi as a potential reserve currency, prolonged depreciation could also severely erode the dollar’s dominant position as the world’s leading currency. The US has long gained from the dollar’s reserve status but who wants to hold onto a diminishing asset?

Coming back to Bill Clinton, he once advised to “follow the trend lines, not the headlines” and with such a deafening roar of newsflow every day, that could prove useful advice in the months ahead.

As ever, we stress our crystal ball is no clearer than anyone else’s when it comes to economics and currencies are particularly hard to predict. I have seen convincing arguments for ongoing weakness and renewed strength when it comes to the dollar in recent weeks and views on the currency will depend on the lens through which people are looking: in the short-term, after substantial falls, it may look cheap; from a longer perspective, it still looks overvalued relative to the long-term average.

What we can say is that tracking how the dollar behaves over the next 12 months and beyond will likely give you a better perspective on overall markets than the daily ebb and flow of economic events.


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Monday, March 19, 2018, 3:14 PM