US dollar rally threatens risky assets

Greenback reaches fresh 11 year highs as expectation of rate rises intensify.

The subdued US rate of inflation in July doesn't suggest Federal Reserve will be in a rush to raise interest rates. Asif Hassan / AFP

The dollar rallied for a third straight day yesterday, pummelling risky assets in its wake as expectations of a rate hike in the US next month pick up pace.

The Bloomberg Dollar Index, a measure of the US dollar against a basket of 10 global currencies, rose 0.2 per cent, bringing its total gain to 4.9 per cent since November 8 – when Donald Trump was elected US president – and taking it to a fresh high since the index began recording data in 2005.

Since Mr Trump’s election, the president-elect has spoken of plans to ramp of fiscal stimulus, causing not just a rise in the dollar but a drop in bond prices amid expectations that inflation will also grow at a faster rate along with interest rates.

While this will be good for savers holding the greenback, it may not be so great for unstable assets such as those in emerging markets which have borne the brunt of the sell-off.

A higher return on the dollar makes investing in risky assets such as developing markets less appealing, especially as a strong dollar will make it more difficult for companies there to pay off debt denominated in that currency.

The Indian rupee and Mexican peso have been particularly hit, with the rupee touching an all-time low of 68.8650 per dollar.

The JP Morgan Emerging Market Currency Index has dropped 3.6 per cent since November 8, while the MSCI Emerging Market index, a measure of listed companies, has decreased 5.2 per cent. The Bloomberg Emerging Market Local Sovereign Index a measure of locally priced bonds in the developing world, has shed 3.9 per cent in the same time frame.

“The dollar’s recent gains can be attributed to two key factors – that being the Trump rally and escalated anticipation of the impending Fed rate hike due on December 13,” said Gaurav Kashyap, the Dubai-based head of futures at AxiTrader.

Mr Kashyap noted, however, that while the rise of the dollar has been at the expense of a number of currencies and not just emerging market ones, the euro and the British pound had problems and were weak before the US election.

The meteoric rise of the dollar has also been a drag on other asset classes such as gold, which is typically bought by investors as a safe haven hedge against a drop in stocks and other yielding asset classes such as bonds and real estate.

The price of gold has dropped 7.6 per cent since the outcome of the US presidential election.

“An appreciating US dollar and rising Treasury yields continue to cause headwinds for gold,” said Carsten Menke, a commodities research analyst at the Swiss private bank Julius Baer.

“Following a short-term sideways trend, prices should resume their downtrend medium to longer-term, pushed lower by receding growth risks, gradually rising interest rates and a stronger dollar,” Mr Menke added.

Whether the US Federal Reserve raises interest rates or not in December remains to be seen, but the closest indicator is the bets made by traders on the direction of federal funds. Those traders see a 100 per cent probability of a Fed rate hike next month, up from 80 per cent on November 7, according to data compiled by Bloomberg based on Fed funds futures.

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