The return of the mighty dollar

Hi everybody!

Today we are still looking repercussions of Donald Trump’s election as the US president and perhaps one of the most interesting is the dollar strengthening. But, why is this happening? And what implications does it have for the world specially for the emerging markets?

It’s difficult following the dollar behavior in a country by country basis so we’re going to use the US dollar index (DXY) for that purpose. This index is a basket that compares the US dollar against six mayor currencies in the world, the Euro (57.6%), the Yen (13.6%), the Sterling (11.9%), The Canadian Dollar (9.1%), The Swedish Krona (4.2%) and the Swiss Franc (3.6%). When the index goes up signals a strengthening of the US Dollar against the other currencies, and this behavior can see in the graphic specially for the period between 2014 and 2015 but, what is really interesting is the accelerated growth it has since Novemeber 8 elections in the US, with a rate of 5.20%reaching 2003’s levels of 102.

Made by the author. Bloomberg Data

This strengthening reflects a change in the investor’s appetite looking for opportunities in the US, which leads in turn to a dollar outflow from other countries increasing the Dollar value. One of the main reasons behind this change are the recovering signals from US economy, with a lower unemployment rate and good growth perspectives, against markets such as Japan and the European Union where their economic dynamic is lethargic to say the least. Part of this growth expectations comes from Trump’s expansive fiscal policies which seems to indicate a higher public expense in the middle run giving a drive to the economy, if this drive will be enough to bring a bigger momentum to the other sectors remains to be seen.

Also, the FED in its Wednesday speech gave hints of multiple rate rises in 2017 as a mechanism to control the inflation that may rise as a result of Trump’s fiscal policies, which will have an impact in the bonds yield attracting even more dollar flows from abroad. The 10 year Treasury bond yield is currently around 2.54% against a 1.40% in this year’s July.

A strong dollar effect may be good for other countries exports because these are paid in that currency and a higher exchange rate results in more local currency, however, two elements will be negativaly affected by this, the imports and the public debt. The dollar value affects directly the imports making them more expensive which leads to higher prices in the local market, in other words importing inflation. Also, the public debt side will be affected in two ways, first the payment of a debt issued in dollars will get more expensive and second, the new issuance of public bonds will need to have a higher rate in order to become attractive to investors, increasing again the public debt.

One fact can counterbalance in some way the strengthening of the dollar at least for oil producer countries, that is the OPEP production reduction accord that could set higher oil prices which leads to higher dollar inflows and lower exchange rates.

It seems this dollar tendency will continue in 2017 and will affect all markets, developed and emerging alike, but will the effects in debt and import stronger than in the exports leading the world in a recession seems the question to answer.

*This post reflects the author ideas and must not be taken as an investing recommendation.

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