The strong dollar is reaching its limits just not today. Despite the rise in risk assets like emerging markets on Thursday, the greenback is not yet through putting global currencies to shame. Remember when the dollar was supposed to tank? Think again.
“If you are wondering how far the dollar can go, then you are certainly not alone,” writes Naeem Aslam, the chief market analyst for Ava Trade in Dublin. “Investors still have a strong appetite for the dollar no matter how stretched the trade is, they want to test the limits.”
Emerging markets like Brazil and Turkey have been hammered by talks of rising interest rates in the U.S. The Brazilian real is down nearly 18% against the dollar this year. The Turkish lira is off by 10.5%.
The first time these markets got whacked by the dollar was during the famous “taper tantrum” of May 2013. The MSCI Emerging Markets Index fell nearly 10% in a month back then, while the S&P 500 rose. Over the last month, since the dollar has been approaching parity with the euro, stocks in the MSCI EM have declined by 3.12% while U.S. equities are down just 1.26% even as financial pundits suggest the equity bull market is finished.
Global investors have pulled nearly $2 trillion out of equities in the past two weeks as investors prepare for higher interest rates in the U.S.
The strong dollar is a huge headwind for emerging markets, especially countries and companies with a lot of dollar debt to pay back. Countries with high interest rates and deficits are in even worse shape.
Still more dollar strength to play out, Ava Trade and Morgan Stanley warned today.
The dollar might be getting stretched, but for dollar neutral guys, we are in the seventh inning stretch.
“Over the last six months, the dollar has rallied on monetary policy and better growth, but I think that divergence with the rest of the world will narrow,” says Ben Rozin, senior analyst with Manning & Napier, a $48 billion asset management firm in Rochester, NY.
The dollar weakened against the euro today for the first time in a week. All told, the euro is down 12.7% against the dollar this year and 24% weaker than it was at the same time last year.
See: Looking At Both Sides Of The Euro Crash — FX Insights
If the market starts to see better economic data coming out of Europe, thanks to the European Central Bank’s own brand of quantitative easing and free money policies, then things might turn the corner. The dollar might not hit parity after-all.
“We think Europe will do be better going forward and we think Japan has a lot of stimulus coming down the pipeline,” says Rozin. “So we are sort of looking at the broader dollar and saying the growth divergence is going to narrow.”
One reason for this belief: there are headwinds to growth here in the U.S. There is still a lot of private debt out there and hiking interest rates will make that debt more costly.
See: Dollar Super Cycle Only Half-Done, Says Morgan Stanley – Bloomberg
The Fed is still data dependent. It’s favorite indicator, the labor market, looks like it will remain strong throughout the summer. That has investors thinking interest rates might hit a whopping 1% by June. Worth noting, the market has been forecasting rate hikes now since late 2012 and been wrong ever since.
For the mere mortals among us, a 1% interest rate means higher mortgage payments for those on adjustable rate mortgages. It also means higher costs for home equity lines, credit cards, car loans and raises capital costs for businesses.
See: Dollar Strength A Tailwind For Caterpillar, Says Company CEO – CNBC
For investors, a strong dollar means weaker commodities and less interest in emerging markets.
Aslam at Ava Trade doesn’t think the dollar is done.
“Dollar strength is the main denominator for the emerging markets,” he says an interview from his Dublin offices. “Unfortunately, in the coming days it is going to become even stronger.”
