If there’s anything analysts seem sure of right now, it’s that a stronger dollar is likely here to stay.
Rising inflation and growth expectations and a hawkish Fed in the wake of Donald Trump’s election victory have helped to drive the greenback to its highest level since 2003…
…and some commentators are concerned that a persistently stronger USD could have some rather undesirable side effects – like triggering EM crises and exacerbating capital outflows from China as citizens desperately try to get their money out of the country any way they can to avoid a further depreciation of the Chinese yuan.
Indeed, it was the so-called “Shanghai Accord” and subsequent”clean” Fed “relent” in March which ushered in a period of dollar weakness earlier this year, allowing panicked markets to (temporarily at least) calm down. Now, questions are being raised about the side effects of renewed (and now structural) dollar strength. Here’s a bit from SocGen:
Icarus once flew too close to the sun and crashed to earth. The dollar is flying high too, supported by the prospect of stronger US growth and tighter Fed policy under the Trump administration as well as concerns about a more insular trade stance. The cyclical peak is likely to come by mid-2017, with the Dollar Index some 5% above current levels (at 106) and nearly 50% up from the 2008 low.
Dollar scarcity. The rise in bond yields and the USD will make it harder for non-US borrowers to roll record amounts of USD-denominated debt. The struggle may aggravate USD scarcity, causing an overshoot in the dollar rally.
There is little doubt that, from an FX point of view, a US policy mix skewed towards more expansionary fiscal policy and tighter monetary policy is bullish for the USD. The question is whether the USD, at a new cycle high and already rich relative to fair value, has already frontrun that policy shift.
Consider that, and then consider the following graphic from Stratfor which shows you which countries are most vulnerable to a continued rally in the USD: