On Friday, the US dollar was on the cover of The Economist. It was also on the cover of Der Spiegel in Germany. Both covers depicted a diving dollar. Most people were waiting for these covers to cover their dollar shorts. They did.
The US dollar strengthened against the euro on Friday. The dollar price of the euro has dropped 1.3% in the last week. Are the bad days for the US dollar over?
Sometimes traders and investors can get too cute for their own good. To use the logic of magazine covers alone to determine if currencies have bottomed or peaked could be dangerously myopic. The underlying premise of such an approach to decision making was that most of the good or bad news should have been in the price by the time magazines start noticing the trend. In the case of the US dollar this time around, it may not be so.
After all, The Economist is not writing the obituary of the US dollar, although it might have been more convincing for the dollar bulls if it did. Thankfully for India, it has been writing India off for the last two years, thus prolonging its growth and the bull run in Indian equities.
In the case of the US dollar, the “newspaper” just warns that a full-blown collapse of the US dollar would be disastrous and that there were good chances that it would not happen. In that context, it is a bullish statement and, if anything, investors should, therefore, be still shorting the US dollar on that basis!
One of the most immediate potential threats for the US dollar is the meeting of the Gulf Cooperation Council (GCC) members (the United Arab Emirates or UAE, Saudi Arabia, Qatar, Bahrain, Kuwait, Muscat) on Monday and Tuesday. This is a routine meeting, but in the light of the gyrations of the dollar and the rampant inflation in some of the GCC countries, it has assumed significance.
The important question is whether they would revalue and de-peg or do one of the two. We will get to know that today.
The chances are high that the countries would be allowed to decide on the revaluation of their currencies but a decision on de-pegging from the US dollar would be postponed.
As has been correctly observed by the governor of the central bank of the UAE, de-pegging is a political decision. This is a wrong time for the GCC countries to abandon the dollar peg. Friendships are not paid back by abandoning the anchor currencies when they are vulnerable.
In any case, it does not seem to make much sense to move to a basket peg when most of the other currencies in the basket are fairly-to-overvalued against the US dollar. If they start to weaken, then the local currency again becomes undervalued, contributing to overheating. So, we should not expect a de-pegging.
Revaluation, on the other hand, is not only essential from a domestic monetary policy standpoint but would also serve their ally. It would send a signal to recalcitrant China. Europe has added its voice to the chorus that demands a revaluation of the yuan. It would help the cause of the US and the European Union if smaller nations set an example.
From an American perspective, the time appears propitious to tighten the screws on China’s exchange rate policy. Domestically, China appears to have reached the limits of growth. Resource costs are rising. Despite the stated intent to hold the line on administered prices, China has been forced to revise upward recently the price on petroleum products and coal. Shortages are said to be responsible for the volte-face. Oil and coal producers had allegedly threatened to cut off further supply unless they were adequately compensated for rising input costs. China’s high inflation and its likely persistence strengthens the hands of insiders who favour an accelerated appreciation of the currency because the exchange rate policy is also constraining the domestic monetary policy. For all these reasons, a signal from the GCC would be timely regardless of whether it actually compels China to move or not. At the very least, it would help to isolate China as the lone hold-out.
However, if the GCC countries do not oblige, the burden of coping with the US dollar would shift right back on to the usual suspects such as the euro. That is why it is too early to say that the euro has peaked against the US dollar. In that case the Gulf states could help the US, which is locked into a reflation policy mode, by allowing the price of oil to ease by raising production in the short term without officially signalling higher production. That would help Wall Street to end a nerve-wracking year on a high note, in time for bonuses unless, of course, fate, weather and data intervene to throw a spanner in the works. More on that next week.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore.These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org