Multi-Asset Insights: Where next for the US dollar?

The latest Multi-Asset Insights looks at the impact of a strong dollar and why any further sharp appreciation might put pressure on global growth.

17 March 2016

Multi-Asset Investments

Over the past 15 years, the global economy has had a tailwind from US dollar weakness, the recycling of petro dollars and trade surplus reserves, and considerable US dollar borrowing.

However, the sharp appreciation in the US dollar over the past two years has placed considerable stress upon the global economy.

Impact on China

The most direct and meaningful impact of a stronger US dollar has been on China, with the nation’s pegged exchange rate importing US monetary conditions into the nation. Growth in China has slowed as export growth has diminished due to a loss of competitiveness (Figure 1).

Downward pressure on growth has led to domestic easing in an attempt to counter this, with the combination of reduced investment opportunities and lower interest rates leading to capital outflows (Figure 2) – placing downward pressure on the Chinese yuan (CNY) peg and exporting deflationary pressure on the global economy.

Impact on the US

A strengthening US dollar has contributed to tighter US monetary conditions. US dollar strength has diminished the competitiveness of the US economy and weighed on what were previously bright spots: the manufacturing and industrial sectors.

This is a result of a decline in the demand for US exports as the exchange rate has appreciated, but also due to the import substitution effect.

This has caused the US trade deficit, ex-energy products, to return to levels reached in the mid 2000s – the height of the US-China circular trade relationship.

Potential for USD to weaken

A weaker US dollar would provide relief to the various pressures weighing on the global economy, such as Chinese capital flows, the CNY, commodities, emerging markets and the US economy.

A weaker US dollar, however, requires an appreciation in other major currencies. We see little ability or willingness for this to take place.

We believe appreciation in either the yen or the euro would slow these economies quickly, while both the Bank of Japan and European Central Bank appear unwilling to allow meaningful strength in their currencies because of this.

Conclusion

We believe we have reached the point where policy divergence has become destructive, with any further sharp appreciation in the dollar coming from a rebound in US growth in turn putting pressure on global growth.

We also see limited ability for the dollar to weaken against major crosses given the lack of ability or willingness for these economies to accept stronger exchange rates.

Our expectation is therefore that major currencies will likely remain range-bound until there is greater evidence that economies have been able to adjust and withstand the pressures being placed upon them by a stronger US.

If the US economy slows and the Fed becomes increasingly dovish, this is supportive of assets like gold, given a lack of ability or willingness for the dollar to weaken against other major currencies.

Important Information: The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.  To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.