The perils of a stronger dollar …

December 9, 2014

The dollar’s star seems to be in the ascendency.  A 314,000 increase in US payrolls for November, combined with some dovish comments from previously hawkish ECB members, has helped the dollar index to rise to 2006 highs.  A move past 90.00 seems on the cards in the short-term, and if the pace of dollar strength is continued then the FX market would need a miracle to slow this dollar-juggernaut before the New Year.  

But a strong dollar is not without its problems as the Bank for International Settlements pointed out in its Quarterly Review that was released over the weekend. The highlights from its latest report include:

There are two things that we can take away from this BIS report – firstly, that emerging markets are at risk from a rising dollar, and secondly, the dollar’s dominance as the major global reserve currency is unlikely to go away any time soon.

Looking at the dollar’s performance over the last 6 months, it is up some 10% vs. the G10, and while some emerging market currencies held their own against the dollar for the first half of this year they have come under increasing pressure in recent weeks. In the last month the Ruble, Mexican peso, Malaysian Ringgit, South Korean Won, Brazilian real and South African rand have fallen substantially versus the greenback. This should give us some indication of which currencies could be at risk in 2015 should the dollar continue to appreciate.  As we mention above, the sharp increase in borrowing in Turkey could also put the Lira at risk in the coming months.

Conclusion:

The fundamental and technical pictures remain solid for the US dollar.
The dollar’s position as the king of official FX reserves is unlikely to be toppled any time soon.
This comes with its own set of problems, credit growth in emerging markets has surged this year, and a large portion of this is in foreign currency, most notably dollars. This means some countries will be vulnerable to a rising dollar as it means that debt-repayments are higher, which could trigger an increase in bad loans, making banks and corporates less credit-worthy.
Back in the 1980s when the dollar was also strong this triggered a wave of EM defaults. Although the EM world is in a stronger position today compared to what it was back then, the EM world is still at vulnerable.
Overall, the strong dollar could be here to stay, but the rising buck could leave a trail of volatility and destruction behind it. 2015 could be a wild year for FX.

Publication source
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