Two tales of a weaker Dollar
As the week that should decide the fortune of the US Dollar continues to unfold, this brief looks at the two very different legacies of a weaker Dollar. For emerging markets-EM and other high beta currency classes, a weaker Dollar can both act as a tail wind and a resistance. The key to which of these two opposing forces prevails is down to sentiment and risk perception. If a USD decline is orderly and not accompanied by defensive positioning and growth concerns, then developing and export driven markets will usually experience net positive FX flows. However, if recessionary fears and (particularly equity) market volatility enters the equation, more often than not, high beta FX pairs will often show a net move in favour of the Dollar.
Analysing market sentiment is an imprecise and difficult science. However, for the purposes of identifying whether a USD decline is positive or negative for this portion of the market should be a far simpler task. Due to the high (and increasingly positive) correlation between developed market equity performance and high beta FX, we can proxy wider market sentiment with stock index performance. In turn, the growth element of the US economy will be pivotal to determine whether markets will seek opportunities to the benefit of EM FX. If they do, elements such as the carry trade in the face of a decline in developed market yields could reemerge.
So far, the much-awaited data brought to markets this week has shown a mixed picture. ISM manufacturing data was inconclusive with positive and negative deviations from prior and forecasted readings amongst the data set. Yesterday’s ADP employment snapshot was more conclusive, sending the Dollar lower. So far this week, defensive market positioning has prevailed with safe havens being favoured over a fresh allocation of risk. Based on this week alone then, EM FX will struggle to gain ground in the context of this weaker Dollar environment.
Discussion and Analysis by Charles Porter
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