The more momentum something gets in the finance industry, the more pundits start citing factors which will inhibit future movement upwards. This idea of financial inertia is applied to Apple’s size in relation to its earnings, to China’s economy, and to the strength of the US dollar. The idea is that after a certain timeframe and historical movement, known factors and their future impact are already “baked in” to a stock price or its currency value.
The tricky thing about evaluating the future is that, in most cases, your evaluation cannot be correct. There are so many variables that go into valuing a company (especially one with the market value that trumps Switzerland’s GDP); how much more difficult is evaluating a currency? One must consider geopolitical landscapes, domestic fiscal policy, trade balances, prices fluctuations of main exports, and consumer spending – to name a few. As if all of these factors didn’t complicate things enough, the day-to-day landscape of the currency market changes constantly. Future price contracts change by the second, sentiment about the global economy fluctuates with each piece of news, and things get so convoluted that it’s impossible to know what will happen from one week to the next.
It is clear, then, that the current exchange rate can’t have “baked in” all information. Just because it is now generally accepted that the FED will raise rates this year, together with the dollar spot price strengthening 20.7% in the past year, doesn’t mean that the USD spot price is up-to-date with the future impact of a rate hike.
There’s no doubt that the dollar has appreciated in anticipation of rising rates. In addition to the upcoming rate hike, many other factors have affected the dollar. From freefalls in many major commodity prices, to foreign economic slowdowns, to a debt crisis that threatens the stability of the second most traded currency, the euro – everything is inter-connected in currency markets.
To figure out where the USD will be going in the next year, we must also look at where other major countries will likely be, as every currency pair has a counter and a base. So let’s look at how valuations of a few major currencies might change.
EUR/USD: The Eurozone will be taking part in QE in order to stimulate consumer spending until September 2016, at €60 billion/month. QE, also known as quantitative easing, puts deflationary pressure on a currency by injecting more money into a financial system. If the FED raises interest rates in September, there will then be a full year where the ECB is weakening the euro while the FED is strengthening the US dollar. That would mean a full year of fiscal policy of the US and the Eurozone moving in opposite directions, doubly weakening the effect on the EUR/USD pair.
USD/JPY: The Japanese yen is in a similar position to the euro, except it has been combating deflation for a very long time. While the Bank of Japan hoped to halt their bond buying by 2014, the BoJ extended the timeline for buying back government bonds to March of 2016. Barring any changes to that estimate, USD/JPY should continue to strengthen until economic data starts tending toward inflation or BoJ no longer unanimously agrees to keep the current policy constant.
USD/CHF: The “Swissy” might just be the best pure fiscal policy play in currency. Simply put, the FED wants to raise rates and the SNB wants to devalue their currency, recently de-pegged from the euro. Switzerland’s central bank interest rate is negative: -.75, a policy implemented to rapidly devalue the franc by discouraging holding savings and buying Swiss bonds. If both sides get what they want, the USD/CHF should strengthen considerably in the foreseeable future.
USD/CAD, AUD/USD: Commodity currencies have been routed due to oil prices and China. The underpinning problem for oil recovery lies in its oversupply. Due to the new lifting of Iranian sanctions, price recovery for crude won’t be likely in the next year to any significant extent. China’s stock market slide and slowdown in industrial production do not bode well for many commodities, as China has made up a huge market of demand. Canada and Australia rely on oil and iron ore exports respectively for much of their GDP, so their currencies will continue to devalue as long as these underlying commodity exports remain inexpensive.
GBP/USD: Cable (nicknamed such because of the telegraph cable laid in the Atlantic Ocean to connect the UK and the US) will be one pair that will likely be more meandering than the other majors. The United Kingdom is in their own interest rate hike roadshow, although they are about a year behind the FED. I wouldn’t be surprised if USD gained against the pound until sterling caught up with a more concrete lift off date for a UK rate hike.
In conclusion, the USD has indeed risen, but there is no reason why it shouldn’t appreciate further in the short-term. The global environment lags the recovery that the United States economy has shown. Further, the pricing in of the future strengthening of the dollar cannot be comprehensive, and there is much more room for the USD to run in these times of global uncertainty and quantitative easing. Where does the dollar go from here? I’d bet my money that it’s going up.