Investors are bracing for the dollar to keep appreciating through at least early 2020 even though the Federal Reserve looks poised to cut rates and the risk of a U.S. recession remains elevated.
The dollar has already surprised investors by holding steady even after Fed reductions in July and September. Now, with the world’s growth outlook decidedly downbeat, Columbia Threadneedle Investments is positioning for the greenback to strengthen against the euro by more than many forecasters are predicting over the next three to six months.
A trio of catalysts should support the dollar through the first quarter, according to Columbia Threadneedle’s Ed Al-Hussainy: U.S. rates exceed most other developed nations, domestic inflation is in a “better place” than Europe’s, and global growth expectations are being downgraded. The senior analyst says the $469 billion asset manager is prepared for the greenback to strengthen toward parity -- a level it hasn’t traded at since 2002 -- against the euro, from about $1.1090 currently, despite the common currency rallying 1.7% against it in October.
Economic theory suggests the dollar should move in the same direction as interest rates, but reality shows that’s not always the case. At the moment, a mix of positive and negative U.S. data, along with occasional progress on trade and Brexit, are complicating Fed policy makers’ assessment of the economy as their two-day meeting in Washington gets underway. After Wednesday’s expected reduction, it’s unclear whether the central bank will cut rates again soon.
“The theory that the dollar should be weakening, along with the Fed lowering rates, depends on whether the rest of the world is in a steady state, with no radical changes in policy being undertaken,” said Scott Kimball, a Miami-based bond portfolio manager whose team oversees $12 billion for BMO Global Asset Management.
“Instead, it’s the exact opposite: Central banks are messing with policy in atypical ways and, in the midst of that, everyone is scrambling toward liquidity doors,” Kimball said by phone. “Negative rates overseas and weak currencies abroad are going to continue to drive people into positive rates and strong opportunities. There’s nothing we see that’s going to deter the dollar, even in these unusual times.”
Kimball said he sees the greenback rising “for a painfully long time” as capital flows from around the world pour into the U.S. and global interest-rate policies drive investors into American bonds, which offer higher rates. As a result, he says he’s been buying more intermediate- and long-term corporate bonds.
Overnight index swaps indicate that markets have priced in almost a full rate cut for Wednesday, and an additional reduction by September 2020.
The Bloomberg Dollar Spot Index was little changed Tuesday after climbing 0.3% last week.
The last time the dollar largely held onto its strength into a recession was before, during and after the 2001 downturn fueled by the Internet bubble’s collapse and the Sept. 11 terrorist attacks.
That year, the Fed cut rates a total of 11 times in 25- and 50-basis-point increments, but the U.S. Dollar Index rose 6.6% from the end of 2000 through the end of 2001. At the time, the dollar appreciated sharply on perceived haven flows, even while the economy was sliding into recession and fundamentals were deteriorating, said Ben Randol, an FX strategist at Bank of America.
The bank sees the dollar appreciating against most currencies except the yen into year-end. Though the greenback is overvalued, unresolved global tensions are one factor that “can keep it on a rising path,” Randol said. On the flip side, “a potentially less threatening global backdrop” could cause the dollar to weaken in 2020, he added.
Granted, there are more than a few people suggesting the greenback may already be at or near its peak. Commerzbank’s Ulrich Leuchtmann and Scotiabank currency strategist Shaun Osborne say softer U.S. growth may help undermine the currency’s haven appeal.
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But even those awaiting a dollar bear market are having a hard time identifying when that might happen. Alessio de Longis, a New York-based multi-asset fund manager at Invesco, says it would take a sustainable rebound in growth outside the U.S., particularly in Europe and emerging markets, and “right now we’re not seeing that catalyst yet.” For the time being, he’s bullish on the Mexican and Colombian pesos and Brazilian real, and using the Swiss franc, Australian and New Zealand dollars as funding currencies.
While a U.S. recession is hardly inevitable, the domestic data is on a “knife edge” and the “margin of safety in 2020 is eroding,” Al-Hussainy said via email. To support growth next year, it would take some combination of steady consumer spending, lower rates, a weaker dollar and fiscal stimulus in the U.S., Europe or China, he says.
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