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Last Updated : Apr 10, 2019 01:17 PM IST | Source: Moneycontrol.com

Are we staring at dollar smile paradox?

There is no major change seen in ECB and BOJ’s policy stance, where asset purchase programmes and low interest rates are expected to prevail for considerable time.

Moneycontrol Contributor @moneycontrolcom

Hitesh Jain

With US Federal Reserve’s monetary policy normalization coming to an eventual halt, some reckon that greenback will lose ground against other major currencies in the coming months. The divergent Fed policy is apparently now a thing of the past, where Fed’s recent pause on rate hikes is in line with the dovish stance of other major central banks.

In fact, there is a looming risk that Fed may do a volte face, delivering a rate cut early next year, if the ongoing economic slowdown aggravates. Cyclical slowdown in the US comes after wide deceleration in industrial activity in Europe, China and Japan.

Nevertheless, US dollar has not ceded ground, withstanding the threat of a recession as well. Indisputably, an inverting yield curve in the US indicates the current growth cycle is long in the tooth after nine years of expansion and waning impact of tax reforms.

The argument is that although US growth is poised to slow and treasury yields fall, the situation is not as ugly when compared with sclerotic growth/inflation and negative yields in Europe and Japan.

There is no major change seen in ECB and BOJ’s policy stance, where asset purchase programmes and low interest rates are expected to prevail for considerable time, straitjacketed by slower economic growth, deteriorating demographics and abysmally low inflation.

Rising nationalism and emergence of far-right wing ideology in Europe, and chaotic Brexit also raises a question on any credible alternative to the greenback. Moreover, fiscal recklessness and rising sovereign debt in countries like Greece, Spain and Italy begets scepticism over the future of a common currency and integrated European Union.

Some experts reckon Chinese Yuan to join the ranks of US dollar as a global currency, given its dominance in world trade. However, it is more of fanciful thinking given the lack of transparency of Chinese regime in managing their economy and fiscal affairs. Needless to mention, adverse repercussions of US-China trade uncertainty on Chinese Yuan and other export-oriented currencies.

Slower US growth theoretically entails a weaker greenback, though the dynamics are quite esoteric in the evolving FX markets. Global financial crisis in 2008-09 taught us that when US sneezes, the world catches a cold. This can be explained by the fact that onset of subprime crisis in US initially triggered a sharp fall in the greenback, however, on the flip side, US dollar rallied later when the contagion permeated to Europe and other regions.

The repercussions were deemed to be ironic, where US dollar rallied despite recessionary conditions back home.

The assumed decoupling theory does not exist in the deeply integrated global economy. Financial markets remain prone to developments in USD 20 trillion economy and that is not going to change before long.

Akin to 2008-09, greenback’s prevalent resilience against the basket of currencies conveys that the deceleration in global economic activity will be pervasive, corroborated by gloomy IMF and World Bank projections. In such a case, USD can ironically smile especially when the economic pain is not ring-fenced to the world’s largest economy.

(The author is Vice President at Yes Securities.)

Disclaimer: The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
First Published on Apr 10, 2019 01:17 pm
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