Has the dollar peaked?

After the first shock of President Trump’s announcement of multi-billion-dollar tariffs on Chinese imports in March had been digested, the dollar embarked on a 5-month bull-run that peaked in mid-August. Between March 23 and August 14, the Dollar Index—a measure of the US dollar’s value against a basket of foreign currencies—gained over 8%. Since then, it has come down by around 1.8%, and speculation is now growing whether the greenback has gone past its peak.

In recent blog posts, whitepapers and webinars, we repeatedly pointed out the three distinct, overarching risk environments that dominated 2018: concerns about inflation, political uncertainty in Europe and geo-political risk. Out of these three, however, only the last one has been detrimental to the American currency. Most of the international tensions of the last 18 months somehow involved or affected the US: issues with Syria, Russia, North Korea, Iran and, most prominently, the trade war with China. In all these cases, investors sold their risky stock holdings in favor of safe government bonds. Many foreign investors—first and foremost the Japanese—also withdrew their funds from the United States, thus depressing the value of the USD.

When the political risk referred to other regions than the United States, however, we observed a slightly different pattern. In periods of political uncertainty in Europe—such as the French presidential race and the UK general election in Q2 2017, the German coalition quandary around the turn of the year and the recent forming of the Italian government—we saw the same ‘flight-to-quality’ flows from stocks to bonds. But it was the euro’s value that was impacted by what happened in the equity and fixed-income markets. This meant that the US dollar was considered a safe haven in those times.

The other environment, in which we saw the greenback prosper, was when investors were concerned about strong consumer price growth in the United States. In this case, the Federal Reserve Bank was expected to raise short-term interest more aggressively, which, in turn, increased the attractiveness of the currency. We witnessed this at the beginning of February, the beginning of May and, more recently, in the week ending October 5. In each case, bond yields rose, while share prices fell, leading to a simultaneous selloff in both markets. At the same time, the higher interest rates resulted in a dollar appreciation.

Even though markets seemed to have shifted back into ‘risk-off’ mode more recently—selling stocks and the dollar, while fleeing into the relative safety of government bonds and the Japanese yen—we still believe that the ongoing political uncertainty in Europe (the looming financial crisis in Italy, Brexit, rising populism in Germany, etc.) is likely to keep the greenback supported against its European rivals. Furthermore, the inflation specter seems to be far from gone and may come back to visit anytime soon.

Christoph Schon, CFA, CIPM

Christoph Schon is the Executive Director, Applied Research for EMEA at Axioma, where he generates insights into recent risk trends with a particular focus on fixed income and multi-asset class analysis. Christoph has been in the portfolio risk and performance analysis space for more than 10 years, having previously worked for Lehman Brothers/Barclays POINT and UBS Delta.