By Paul Single and co-author Alan Rose
The first three months of 2016 marked the worst quarter for the U.S. dollar in several years, ending a lengthy rally that had seen the greenback achieve a cumulative gain of more than 30% since May 2014. The WSJ Dollar Index, which measures the dollar against a basket of 16 currencies, declined 4% in the first quarter, its biggest drop since the third quarter of 2010.
There have been significant changes in the value of the dollar since the onset of the Great Recession. Moving to stimulate the economy, the Federal Reserve Board cut short-term interest rates to nearly zero and launched numerous forms of quantitative easing. This helped push down intermediate and longer-term interest rates, causing the dollar to weaken and helping exporters in the manufacturing sector by making their products more competitive in overseas markets. However, as time moved on, the dollar began to stabilize as the U.S. economy bottomed before other G7 countries and currency markets factored in a slower rate of global economic growth.
In 2011, the dollar’s strength began to build up steam as a divergence in the monetary policies of G7 countries began to take hold. The Fed had front-loaded much of its stimulative measures, with other countries later following suit and cutting their own interest rates amidst a weak global economy and deteriorating trade flows. Beginning in 2014, the dollar began to rise sharply as commodity and energy prices collapsed, damaging the currencies of resource-reliant emerging market nations.
The first-quarter trend reversal and decline in the dollar caught many by surprise. The U.S. economy continues to outpace growth in most other industrialized countries and the Fed has begun to raise rates, factors that normally are bullish for a currency. However, currency markets reacted based on a change in expectations of future central bank actions. Specifically, the Fed turned more dovish in terms of its guidance on further rate increases this year. After indicating at the end of 2015 that there might be four quarter-point rate hikes in 2016, the Fed subsequently signaled that only two such increases were likely. In other words, after initially projecting that rates might rise by 100 basis points this year, the Fed is now suggesting that the increase might be only half that. By contrast, the Bank of Japan, the European Central Bank and the central banks of Sweden, Denmark and Switzerland have all pushed their rates into negative territory, attempting to spur home-country economic growth by weakening their currencies.
Changes in the value of the dollar can have wide-ranging effects on the earnings of U.S. companies. As mentioned, a weaker dollar generally is beneficial to export-oriented firms, including many domestic manufacturers. Conversely, the dollar’s prior strength generated headwinds for many U.S.- based multinationals that generate a significant portion of their revenues abroad.
As for the future of movements in the dollar, we anticipate that it will trade in a fairly narrow range this year, without the significant type of change we saw in the first quarter. While foreign central banks are expected to continue to use monetary policy as a tool to weaken their own currencies, there is still a significant uncertainty as to the trajectory of interest rate increases by the Fed and the growth prospects of the global economy. We are monitoring developments closely and factoring them into our investment strategies.
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The Standard and Poor’s 500 Index (S&P 500) is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.
The MSCI Emerging Markets (EM) Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada. As of June 2007 the MSCI EAFE Index consisted of the following 21 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
The Barclays Aggregate Bond Index is comprises U.S. government, mortgage-backed, asset-backed, and corporate fixed income securities with maturities of one year or more.
The Barclays U.S. Municipal Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed tax exempt bond market. The index includes state and local general obligation, revenue, insured, and pre-refunded bonds.
The Barclays U.S. Municipal High Yield Index measures the non-investment grade and non-rated U.S. dollar-denominated, fixed rate, tax-exempt bond market within the 50 United States and four other qualifying regions (Washington, DC, Puerto Rico, Guam and the Virgin Islands).
The Wall Street Journal Dollar Index (WSJ Dollar Index) is an index (or measure) of the value of the U.S. dollar relative to 16 foreign currencies.
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