Leith Wheeler’s outlook for the rising U.S. dollar.
A Note on Our New Look
You may have noticed that there is a new look and feel to Leith Wheeler. For us, continuing the evolution of our company’s brand was not only an opportunity to define how we do business, but to also express what we believe in. And that is where our new tagline “Quiet Money” comes in. It’s about our belief in avoiding noisy market trends and flashy predictions. It’s about always taking a long term view and staying committed to our value investing philosophy. And last but not least, it’s choosing to never make noise about ourselves as we go about the business of making money for our clients. Steadily. Confidently. And ever so quietly.
U.S. Dollar, Phoenix Rising?
The rapid ascent of the U.S. Dollar since last July has, understandably, dominated headlines and become a focal point for financial markets in 2015.
Such a move in the world’s reserve currency has important consequences for the global economy, including monetary policy, economic growth prospects and financial stability risks.
Dispelling Common Currency Misconceptions
Since mid-2014, the U.S. Dollar has appreciated approximately 20% relative to the trade-weighted index which measures the dollar relative to other world currencies and the Canadian Dollar. The U.S. Dollar appreciation has been even larger – approximately 25% – when measured with reference to the U.S. Dollar Index (“DXY Index”). The DXY index measures the U.S. Dollar against a fixed, narrowly defined basket of currencies: The Euro, Yen, Pound Sterling, Canadian Dollar, Swedish Krona and Swiss Franc, with a significant weight given to the Euro.
The extent of U.S. Dollar appreciation, however, is not without precedent. In the late 1990s, the U.S. Dollar appreciated by approximately 50% as the U.S. economy accelerated and saw significant portfolio inflows into the technology sector in the early 2000s. The U.S. Dollar also appreciated almost 100% in the early 1980s following the aggressive monetary tightening under Federal Reserve Chair Paul Volker, which ended only with the 1985 Plaza Accord, an agreement between Germany, France, the United Kingdom, Japan and the United States to intervene and depreciate the U.S. Dollar.
This short recap on U.S. Dollar history is intended to remind investors that recent U.S. Dollar strength, although larger than we have seen in the past decade, should not be viewed as outsized relative to U.S. Dollar moves over the past century, and does not preclude further appreciation.
For Canadian-based investors, the move in the Canadian / U.S. Dollar exchange rate has been entirely driven by the U.S. Dollar component of the equation. In fact, since mid-2014, the Canadian Dollar is 6% stronger against both the Euro (Canada’s 2nd largest trading partner after the United States) and 2% stronger against the Mexican Peso (one of Canada’s largest export competitors). This is despite a 50% decline in oil prices which, many argue, is the primary driver for the Canadian Dollar’s weakness.
Justification For U.S. Dollar Strength
Although the extent and pace of recent U.S. dollar strength has been swift, our view is that the currency moves are largely justified and further appreciation is a distinct possibility should the U.S. economy continue to recover, and U.S. monetary policy starts to be normalized with the raising of the Federal Funds rate later this year.
There are several reasons for this. First, the U.S. economy has recovered from the Great Recession far more quickly than many other developed economies and is now leading the global economy out of a sustained period of below trend growth.
Second, the relative strength of the U.S. economy and comparative weakness globally, has prompted a marked divergence in monetary policies around the world. Nearly every major economy has eased monetary policy in the past 12 months, including Europe, Japan, China and Canada amongst others. While, in contrast, the United States has been preparing to raise interest rates. Even without interest rate hikes from the U.S. Federal Reserve, the relative size of central bank balance sheets – an alternative form of monetary easing – are expected to diverge over the coming year as Europe, Japan and other countries ramp up their asset purchase programs and expand their Reserve begins to unwind theirs.
Finally, the structural drivers behind the U.S. Dollar, the budget deficit and the current account deficit – often referred to as the U.S. “twin deficits” – have improved considerably since 2006. Political division between the U.S. house and senate, combined with an improving economy, has resulted in a significant reduction in the U.S. budget deficit. In addition, the deleveraging U.S. consumer and the U.S. energy renaissance has allowed the U.S. to scale back imports relative to exports and consequently reduce the current account deficit from a peak of 6% of GDP in 2006 to about 2% in 2014.
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