Just a month ago, most analysts remained bullish on the U.S. dollar in anticipation of a Fed rate hike. However, this week, the greenback has fallen quickly to its lowest level in three months. Even today, there is still little reason for the U.S. dollar to be sold so heavily, so when this kind of price action happens, it makes us rethink what’s going on. With all the persistent financial turmoil since summer, international investors are now looking beyond short-term factors and are looking more at the bigger picture.
First, let’s take the potential side effects of income inequalities. Part of this came from the massive quantitative easing that central banks had to take as a temporary fix to the Great Recession of 2008. National income has been distributed unevenly as a result. The true fix for this is through fiscal policies. So until these material structural changes are made, monetary policy cannot be aggressive. As a result, the market may now be focusing beyond the Fed’s potential first 25bp lift-off, understanding that the path beyond will remain very flat. Regardless of what Fed officials say, the futures market has decided to push back its outlook for a Fed rate hike, giving only a 30% probability of a 25bp hike in 2015. If this is the case, this will certainly weigh on the USD too.
In addition, there is the question of the U.S. dollar as a reserve currency. The struggling emerging markets’ economies have huge debts denominated in the U.S. dollar, so the strong dollar only compounds the problem. It could be that the major central banks around the world are starting to diversify their foreign currency reserves out of the dollar. If this is the case, it will certainly have long-term negative effects.
My View: A month ago, it seemed that the stronger U.S. economy, strong dollar and Fed tightening would be the harbingers to bring the rest of the world out of its economic woes. Now, it’s the opposite where the rest of the world is expecting the U.S. to slowdown to close the income gap. This correction may take longer than we had originally anticipated, in which case the greenback may not rally as soon as we think either.
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