One of the main themes in April was the resurgence of the US dollar with the Bloomberg dollar index rising by almost 3 per cent since the start of last month and almost erasing all its 2018 declines.
It has also helped the dollar buck a seasonal pattern that often sees it lose ground in the month of April, every year since 2010. This dollar strength has not only been seen against major currencies such as the euro, Japanese yen and sterling but it has been across the board taking in gains against emerging market currencies like the Turkish lira and Argentine peso. The resumption of dollar strength is a particular concern to regional companies already facing headwinds from higher interest rates, cuts in oil production and geopolitical tensions.
Such an about turn in the dollar’s fortunes has coincided with a number of developments, in the first instance related to interest rates where first quarter growth trends are helping to restore correlations between currencies and bond yields.
Although the US first quarter GDP growth rate of 2.3 per cent was softer than in the fourth quarter of last year, this was still much stronger than the trends underway in the UK and in the Eurozone. As a consequence, question marks have arisen about monetary tightening by the Bank of England and the European Central Bank, while the Federal Reserve remains on track to tighten monetary policy at least twice more in 2018.
At the same time, geopolitical and trade risks have abated for the moment leaving markets to focus on more traditional technical relationships. The easing of tensions between the US and North Korea has been one of the most pivotal developments of the last few weeks, reversing months of rancor which also saw the dollar depreciate more or less consistently since the summer of 2017. On trade, diplomacy has also broken out between the US and China after the threats and counter threats of the first few months of the year. This has also helped to stabilise the dollar, as fears of a spiral into global protectionism have eased.
With the US economy continuing to grow solidly, as shown by the latest April jobs data, which saw the unemployment rate fall to 3.9 per cent, the focus has returned to vulnerabilities elsewhere. In sterling’s case doubts about BOE monetary tightening have surfaced following stagnant first quarter growth data, while Brexit tensions are also back at the forefront.
The Eurozone has also lost momentum in the first quarter, which has cast doubt on the speed of ECB policy normalisation, while the Bank of Japan has abandoned its pledge to reach its 2 per cent inflation target by 2019.
In the emerging market space as well, a broad resumption of risk aversion, reflected in the ongoing weakness of stock markets around the world, is hurting a number of EM currencies. The peak in the US stock market coincided with the start of the slide in EM currencies in late January, with the latest rise in bond yields aggravating the pressure. Turkey’s overheating and uncertainty over its policy response in the context of the upcoming elections has placed a spotlight on the Turkish lira, while the Argentine peso has collapsed due to its bulging twin deficits forcing its central bank to raise interest rates twice in the course of the last week alone.
For many companies in the GCC, this resurgence in the dollar is alarming as it threatens to present another headwind to growth, at the same time as investors are worried about rising interest rates, cuts to oil production as well as uncertainty about geopolitics.
However, it is probably too soon to conclude that dollar strength is here to stay. Just as the concerns about protectionism and geopolitics eased last month, they could just as easily return, and are quite likely to. The latest round of trade talks between the US and China saw no concrete results, and the upcoming North Korea summit will probably have to meet a high bar to succeed.
The loss of growth momentum in many parts of the world is also likely to be temporary, with the result being that interest rate driven dollar strength may also not last. While it may be premature to conclude that dollar weakness has been replaced by dollar strength, forex volatility is probably one thing that cannot be counted on to go away.
Tim Fox is group chief economist and head of research at Emirates NBD