According to Societe Generale, if you stand in the way of the U.S. dollar in the next year or two, you’re likely to get run over. A March 12th report from Societe Generale’s Cross Asset Research argues that the dollar’s bull run is really just gathering steam, and likely has a good bit left to run. SG’s Vincent Chaigneau and colleagues suggest that USD/Euro parity is the next stop on the U.S. dollar express, and, moreover, that key event is likely to happen within 12 months, says the entire consensus. Which makes one wonder – will it do the exact opposite?
Commodity price collapse and US Dollar strength hammering EM currencies
Chaigneau poses the question: “Are emerging market currencies falling because commodity prices are, or rather, are commodity prices falling because the dollar is rallying?”
He answers the question by saying it is likely more the latter than the former. He points to the 23% fall in the price of sugar since mid-October almost exactly matching the real’s fall over the six months, maintaining the (Brazilian) Real price of sugar basically unchanged. Moreover, that means if the Real price of sugar doesn’t go up as the Real drops, then “Brazil can only gain from its exports if volumes pick up.” On the other hand, “the US as a sugar importer gets the benefit of the fall in import prices”
Deflationary cycle
The SG report also highlights that the combination of a rising dollar and dropping dollar-denominated commodity prices is clearly a disinflationary force for the U.S. economy. It also serves as a reminder that “inflation rates during the 2003-2011 period were distorted higher as the weak dollar boosted import prices.”
The analysts point out that the rising dollar is hurting exporters’ dollar-denominated earnings, effectively braking inflation, meaning the relative strength of the dollar will “anchor expectations about how far the Fed rate-hiking cycle can go”
Unfortunately, weaker U.S. growth prospects will not necessarily provide a lot of support for other currencies, especially countries with current account deficits or who are dependent on U.S. demand to drive growth.
Chaigneau and colleagues note: “A dollar turnaround will only come either because the US economy is still growing but the Fed is providing enough reassurance that the peak interest rate will be lower than is priced into markets, or because dollar strength boosts growth elsewhere. And ‘elsewhere’ in this regard may mean Europe. A turn in the Treasury/Bund yield spread, a pick-up in European growth sufficient to spark an ECB rethink – these aren’t imminent, but that’s what is likely to be required to stop the dollar overshoot. By the time they happen, I suspect we’ll have seen a fair bit more dollar strength.”
Separately, Naxitis Research notes:
For these reasons, we expect the EUR/USD to extend its decline in coming months and reach parity in June through to September. Further out, several factors suggest the EUR/USD should recover gradually in 2016. As the US dollar will start to be overvalued, more and more large US groups will complain about the strength of the currency when they publish quarterly earnings. Also, more signs of an improvement in Eurozone’s situation at the end of the year (spurred by low crude oil prices, a feeble euro and low interest rate) could prompt some profit-taking on short positions held by speculative accounts, which currently stand at a record high of EUR 25bn.
Many other sell-side firms also expect the US dollar to gain further on the euro. Which leaves one to wonder what will actually happen?
