Year 2017 made a surprise sway to the dollar, while the US economy supposedly did better than expected, the dollar on the other hand moved down against a basket of currencies.
Some influential agencies talked the dollar down like Bank of International Settlements (BIS). Hyun Song Shin, head of research at the Basel-based Bank for International Settlements, said in a speech that “when the dollar is strong, risk appetite is weak”.
“The dollar as a barometer of leverage and risk-taking capacity has implications for both financial stability and the real economy,” he said at the London School of Economics.
It makes sense for some trades in the rest of the world to talk the dollar down as it helps all merchandise imports into all these countries regardless of the origin of these transactions, but it is subtle for US to fully benefit from a weak dollar. But for exporters it is another matter. There are many functions to look at apart from the risk appetite question.
First of all last year saw Euro appreciate by 14% against the dollar, GBP by 9.4%, Yen by 3.7% and CHF by 4.4%, these follow a pattern that conventional wisdom would fail to explain.
Rupee appreciated as well.
The dollar clearly has taken a mysterious trajectory since the time the Fed initiated the tightening cycle. Conventional wisdom would have ordained a hardening of the dollar as the inflationary pressures would be released with the tighter interest rates, but no, this time the opposite happened.
It almost coincided with the President himself talking the dollar down, saying that it was too ‘strong’. In fact since then it has remained weak.
Does this help the global recovery, well yes and no. The dollar is inversely correlated to the commodity prices, when dollar moves up the commodity prices denominated in dollars move down, all else remaining same. But this time we have a mixed bag of results.
Crude for example is misaligned to this general pattern, it is entirely range bound to supply signals and is completely estranged from the strength or the weakness of the dollar.
The rest of the commodities from Coal to Metals and non-metals is more nuanced by what happens in China, whether capacities are taken out or added; China is still 50% of the global consumption in most of the categories, so that explains.
The question that lingers now is the following:
If commodity prices do not sync with the dollar movement as it did in the past, all else remaining same, are we missing something that predicates global trade in the new paradigm of exchange rates?
The real issue is that the current tightening cycle of Fed is divergent to the stand taken by almost all other central banks, who have either remained committed to further bond purchases or have remained neutral to credit easing. In fact outside of U.S. the credit markets are doing a shade better. Dollar credit on the other hand is going through the tightening cycle.
The central bank divergence is not a completely new thing. It has happened in the past as well.
We will have to watch for the next signals that are yet to be priced in. For now the markets would be looking for new cues after tax cuts are about to settle.