By Michael McKeown, CFA, CPA - Chief Investment Officer
We are less than a month away from the new season of Game of Thrones (!). One of the most exciting aspects of the show is the unpredictability and that what you think is going to happen, hardly every does. Once someone gets momentum for sitting on the iron throne, the writers throw the viewers a curve ball.
In a way, the moves in currency markets are similar. The one way street higher in the dollar from 2011 to 2015 seems to be meeting a speed bump. It is not what markets anticipated with the Federal Reserve being the only central bank in the world to embark on a hiking cycle at this point, but that is what makes the markets (and the story) interesting.
In the last 30 years, there were four previous hiking cycles and we just entered the fifth this past December. In previous cycles, the U.S. dollar index tended to rally in the months preceding the first interest rate hike, followed by the dollar falling in the two years after the first rate hike (the exception being 1999).
So far, the dollar index is sticking to the playbook. Expectations for the hiking cycle were fully baked into the currency when the Fed hiked the fed funds rate on December 15th. The dollar is down 5% since then.
Assets with foreign currency denomination will be a place for opportunity if the dollar continues its fall. Below we show the MSCI Emerging Markets Index denominated in the U.S. dollar and local currency. Because the dollar appreciated against emerging market currencies, the MSCI EM Dollar Index underperformed by 25% the last five years. As can be seen in the bottom graphic in pink fuchsia, this underperformance flattened out and ended in January. Since then, emerging market currencies made up ground lost to the dollar.
The high correlation of the dollar and other risk assets (from equities to commodities) seems to be fading. Traders and analysts continue to discuss the silent 'quid pro quo' among central bankers, that is, to stop with the currency wars as the strong dollar hurts global exports. In her speech yesterday, Fed Chair Janet Yellen expressed concern over the global economy and how a fast pace of rate hikes could do more damage. In turn, the dollar continued to tumble, so this will be important to watch as the hiking cycle continues.
Which currency will take the throne? It may not be the one that everybody thinks.
This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.