It’s time to take off the dollar blinkers, exclaims Bloomberg's Mark Cudmore, and take stock of what’s really going on in markets.
The dollar has been so strong since the election that it’s clouding the vision of all US-centric observers. Any market decision requires an accurate assessment of the state of play. So apart from the roaring greenback, what are the other themes?
First thing to clear up is that most Asian emerging-market currencies are doing well. Indian rupee is at a record low? Rubbish. That’s only versus the dollar. The rupee is an outperformer since the election, and has rallied 5% on a trade-weighted basis since its year-to-date low in June.
When will the yuan stop depreciating? Four months ago. Catch up. It’s at the stronger end of a multi-month range.
For European investors, these currencies not only offer yield, but also capital appreciation. The corollary is that any U.S. investor who thinks they’ve done a great job playing the USD strength versus INR and CNY has actually underperformed – they’ve paid negative carry for less return than just shorting EUR/USD, let alone the returns from long USD/JPY.
Importantly, away from the panic-mongering headlines, these EM currencies aren’t in a negative spiral at all.
So which currencies really are in genuine free-fall?
The Turkish lira is, with its large external debt pile. For example, TRY/INR is down 35% during the past two years. Again, stop worrying about the rupee.
Another market conclusion from registering the power of dollar rally is that recent commodity strength is even more dramatic in local currencies. For example, copper has gained 45% in lira terms during the past month.
The effective liquidity tightening caused by dollar strength has been well documented and is a valid concern. But it’s also important to note that since the U.S. is the major consumer of the world, there’ll be a significant boost to the real economies of exporting EM economies.
A final thought: at what point does USD strength become auto-correcting? Not yet perhaps, but it’s a serious disinflationary pressure to be aware of. If inflation doesn’t take off as expected, Fed hikes may not arrive as quickly as anticipated, which would remove a key pillar of the USD rally.
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