It’s all relative
For King, the way forward is less about the diverging path of interest rates and more about relative growth rates.
“The US economy is likely to strengthen further this year, but we also think there will be a pick-up in growth in Japan and Europe – and maybe even the UK – and the decline in the US’s relative growth advantage is likely to lead to some weakening in the dollar.”
However, he adds: “We don’t think the Japanese or European central banks are particularly keen to see their currency strengthening, so if you saw the euro going up quite sharply against the dollar, for example, you might expect another move by the ECB as you saw late last year to effectively inject liquidity and knock the currency back a bit.”
Batten agrees, saying: “It has been easy to talk about dollar strength in broad terms over the past two years as it has appreciated against every other currency. This year we expect a significant amount of diversity within the broad dollar basket.
“Several countries have significant structural problems: sterling has to cope with a sizable current account deficit, a Brexit vote and a fiscal retrenchment, while the Australian dollar and New Zealand dollar continue to look expensive versus their main exports and vulnerable to further negative China news.”
Three strikes and you’re out
For David Absolon, investment director at Heartwood Investment Management, there are three strikes against the view that the dollar can sustain its sharp upward path.
The first of these, he says, is the sheer strength of the move already seen both in isolation and on a trade-weighted basis. The second is that, given the level of consensus within the market, being long the dollar is a very crowded trade. The third strike is that the macro data on which much of the belief in dollar strength was predicated, has softened somewhat, leading investors to question the Fed’s ability to follow through on its plans for further rate hikes this year.
“Should the Fed backtrack on its intentions, you could even see the dollar weaken,” Absolon says.
Growing concern
John Bilton, global head of multi-asset strategy at JP Morgan Asset Management, believes the movement of the dollar in 2016 rests with the decisions to be made by the Fed. Should growth disappoint, it might be forced to renege on its rate hike plan. However, should growth exceed market expectations, which is currently pricing in only two hikes in 2016, this will move closer to the Fed’s outlined four hikes.
“In the early stages of the Fed’s policy normalisation, we expect a repricing of the path of Fed hikes to provide support for the dollar. The market currently prices just two hikes each in 2016 and 2017; we believe the strength of the US domestic economy warrants four per year.”
Ultimately, a terminal rate around 3.5% rather than around 2%, as is currently priced, will again lend support to the dollar. Bilton expects to see further upside in the dollar, but says it will be modest and limited.
“Since the global financial crisis, the world economy has been underpinned by the steady, if unexciting, expansion in the US. As a result, we weathered the eurozone crisis, the slump in commodity exporters and, later, the slowdown in trade and manufacturing that centres on China’s economic rebalancing.
“In some ways the US currency is now doing what it should – acting as a natural governor on growth and policy until growth differentials relax.
“Simply put, the longer dollar strength persists, the more 2016 will look like 2015. The sooner the dollar stabilises, the quicker we will see sentiment recover and emerging economies repair.”
According to King, a counterpoint to this is that “the US authorities are well aware that the strong dollar would cause further problems for the emerging markets, including China, and I don’t think they want to see that. Unless the Fed sees compelling domestic reasons for tightening monetary policy in the US, it is likely they will hold off.”
The most likely scenario, he believes, is that the dollar trades roughly sideways. As a result, he has increased his exposure to the yen and the euro, while turning neutral on the dollar from an overweight position.
