Currency Kerfuffle

  • Currency Kerfuffle
  • The Dollar, Trade Restrictions and Their Impact on EMs
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Ryan takes a look at the recent dynamic around the U.S. dollar.

I married into an internationally dispersed family, and my European wife has helped me widen my perspective of the world beyond the United States. This comes at a cost, though, in the form of international travel to see her family. Lately, we have been discussing whether 2018 will be the right year to begin taking our family to visit her relatives in Germany or France. Setting aside the difficulty of traveling with three young children, I hesitate at the cost—which, of late, has only grown steeper.

For more than a year, the U.S. Dollar (USD) has been losing value relative to most other currencies. When asked about this trend this week in Davos, U.S. Secretary of the Treasury Steven Mnuchin seemed unconcerned, and even supportive. This began a nervous forty-eight hour period that illustrated the anxiety that currency values can create. Ultimately, though, we expect the situation to have little impact on economic activity or asset prices.

The value of the USD has declined not only relative to most major currencies, but also when considering the trade-weighted dollar, an index of the USD’s value against all its major trading partners. In the context of a well-performing economy and rising interest rates, we would expect steady or increasing exchange rates. Why has the dollar depreciated?

Exchange rates are determined by the demand for products, services and debt denominated in one currency relative to another. Debt issuance, sovereign rate guidance, debt ratings changes and trade imbalances all affect the valuation of currencies.

In the case of the recent decline of the USD, capital flows seem to be a main driver. It’s not that U.S. asset markets are falling behind; instead, other markets have risen. In all major centers, we are seeing solid growth in manufacturing activity as well as optimistic consumer and business sentiment. Investors have the luxury of bountiful investment choices, globally. Equity fund flows bear this out: most weekly net investment flows in 2017 were negative for the U.S., but positive for the rest of the world. Essentially, the U.S. has gone from being the source of the best investment opportunities, to merely being one of many great destinations for capital. The dollar’s slide can be at least partially attributed to this change.

Furthermore, while U.S. long-term interest rates remain much higher than those in Europe, the differential between sovereign yields has narrowed. This has prompted some reallocation away from the U.S. and its currency.

This situation with the U.S. dollar could easily continue for a while, given the age of the U.S. expansion and strengthening growth in Europe. While this will be interesting for participants in foreign exchange markets, we do not believe it will have a great impact on the U.S. economy. Ultimately, trade flows, the movement of goods and services across borders, may not be influenced much by the recent realignment in exchange rates.