By Tim Seymour
There's a change afoot for the U.S. dollar, and like other major trend shifts in the direction of the "greenback," this is not expected to be a short-term move, nor has this change taken place overnight. The impact for commodities and emerging markets could be dramatic.
The USD is now rallying in risk off and risk on environments as we view correlations that are well entrenched from the early days of the financial crisis breaking down. The dollar is rallying not just as a "risk off reaction," but also even as parts of the global economy are recovering. While Europe is far from solved and Chinese growth remains a major question mark, the world is doing better.
The price action we are seeing in the dollar is fundamentally different than what we have seen in the last five years. Like structural dollar moves over the last 50 years, this trajectory change in the USD has taken two years to establish its new path, and it will be a theme for global investors well beyond the next two years. The dollar broke the bear trend in 2011 with one last thrust to the downside before a period ahead of consolidation and basing that lasted through the Fed statements of last summer and fall. Now it's clear that the Fed has maxed out on monetary policy and dovish comments.
The other fundamental factors at work that are part of the short-term dollar support include policy changes in Japan, Europe, and even China. Look at the chart of U.S. dollar/yen and this tells you something much bigger is afoot with the USD, not just Japanese policy. Italian elections and Draghi comments signal that European Union (EU) tightening is not happening soon and that EU referendums coming back in vogue. A quick look at the commodity currencies (AUD, CAD, ZAR, and MXN) tells you China is not able to recreate the same commodity demand backdrop that drove demand past the 2008 crisis and well into the peak of these currencies into 2011, 2012.
U.S dollar moves are five- to 10-year events that incorporate yield differentials, policy changes, and global growth dynamic, thus dictating capital flows and macro speculation. We are seeing capital flows and macro speculation in the last three weeks that are telling a big story, beyond the Fed potentially taking away the stimulus punchbowl.
Japan is mired in deflation, Europe will be battling austerity and drag from the periphery, the U.K. is battling a housing bubble still, and China is battling how to balance its social fears with a planned economy that isn't really serving the masses. The dollar has already had an appreciable move higher (+5%) in the last month, but most investors have not noticed because the U.S. stock market has been going higher and industrials have done well.
If the dollar continues its path higher, we know that emerging markets and commodities will be heavy. But also be wary of the impact and drag on U.S. multinationals and even higher growth linked to U.S. equities.