By Mansoor Mohi-uddin
Published: April 19 2010 19:01
This year the currency markets have been torn between fears over budget deficits in the eurozone and hopes that the global economic recovery is gathering pace. Amid all the noise and angst, however, a more profound change seems to be taking place, with the dollar starting to behave as a growth currency, appreciating at the same time as investors seek more risk in equities, commodities and emerging markets. In short, the exchange rate markets seem to be undergoing one of their periodic “regime shifts”.
The picture was very different over the past decade. Following the bursting of the internet bubble in 2000, the dollar tended to benefit when investors turned risk-averse, and weaken when confidence returned to financial markets. As equities rallied from 2003 to 2008, the greenback fell to a record low of 1.60 against the euro. But when financial markets were gripped by risk aversion after the demise of Lehman, the dollar soared as investors uniformly dumped assets elsewhere and sought refuge in US Treasuries. As a result, the greenback became identified as a safe haven currency, along with the Japanese yen and the Swiss franc. The dollar’s safe haven reputation has been enhanced this year by concerns that the eurozone may start to break up. The renewed decline of the yen as Japan only slowly emerges from recession and the frailty of Britain’s economy have also supported sentiment towards the dollar.
But the greenback’s resilience is also coming at a time when commodity currencies such as the Australian dollar, Canadian dollar and Brazilian real are trading strongly. It also is occurring when oil prices have risen back above $85 a barrel and the S&P 500 index has returned to levels prevailing before Lehman’s bankruptcy in 2008. Thus dollar strength against the euro, pound and yen is occurring hand-in-hand with risk-seeking behaviour in global asset markets.
A stronger greenback, rallying equities, higher commodity prices and buoyant emerging markets are reminiscent of the 1990s, when the dollar was last viewed as a growth currency rather than a safe haven reserve. There are a couple of key reasons why the exchange rate markets could experience the same behaviour again in this decade. First, the Federal Reserve is likely to be the first of the leading central banks to raise interest rates this year. America’s economy is recove
ring faster than Europe and Japan from recession. In contrast, the European Central Bank is unlikely to begin normalising monetary policy while swathes of the eurozone remain plagued by concerns over their finances.The Bank of England, also, will remain reluctant to begin raising interest rates as its forecast of future inflation remains at the low end of its target range. And the Bank of Japan may need to move in the opposite direction by easing monetary policy further to combat deflation in Japan’s economy. Thus, the Fed is in the best position to follow the Reserve Bank of India, Bank Negara, Bank of Israel, Norges Bank and the Reserve Bank of Australia in raising interest rates this year. Second, the three largest holders of dollar-denominated capital in international markets – US fund managers, foreign central bank reserve managers and sovereign wealth funds – all appear to be viewing investments more favourably in America even as they allocate resources towards equity and commodity markets.
US investors have a colossal $37,000bn of assets under management. According to the latest Federal Reserve and mutual fund data, American fund managers have started increasing their exposures to domestic assets within their portfolios. Central banks worldwide manage $8,000bn of reserves. In the International Monetary Fund’s most recent currency composition survey, central banks have raised the share of their reserves held in dollars at the same time as increasing the share held in commodity currencies.
Of course the dollar isn’t about to lose its safe haven status overnight. Investors are still likely to seek highly liquid US Treasuries during times of extreme duress. But the shift towards the greenback when investors seek risk needs to be absorbed by a generation of currency participants who only entered the markets after the advent of the euro in 1999.
More significantly, policymakers also need to be aware of shifts in the greenback’s position in the currency markets. Just over a decade ago, dollar strength during the internet bubble caused the yen to weaken sharply, leading to the Asia crisis of 1997-98. The rise of the greenback also led indirectly to the Russia crisis of 1998 and forced Brazil to devalue the real in 1999. Fortunately, in 2010 the dollar is still marginally undervalued against the euro. But a period of greenback strength in the next few years, at a time when policymakers are lulled by a recovery in the global economy, may spark future crises in the currency markets.
Mansoor Mohi-uddin is managing director of foreign exchange strategy at UBS
Copyright The Financial Times Limited 2010.
0 comments:
Publicar un comentario