One has to be careful when evaluating the performance of the USD, because everything is time sensitive and viewed from a specific perspective. Last week, Morgan Stanley took a favourable view of the USD, with the expectation of a strong upside correction during the month of May. This is largely due to the perception that there will be currency appreciation in markets with low yields, which will drive worldwide risk-off sentiment. We have already seen the impact of a prolonged period of dollar weakness on commodities markets, and it is not positive. Morgan Stanley is of the opinion that the short-term prospects for the USD are bullish especially against emerging market currencies, as well as commodity-related currencies such as the Canadian dollar and the Australian dollar. Recall that the Canadian economy is heavily reliant on crude oil and the Australian economy on its mineral resource wealth.
The US Dollar Index
The US dollar index – a key measure of the strength of the USD – declined on Wednesday, 11 May 2016. It was trading at 93.809, down 0.51%. The US dollar index has been declining since 22 April 2016 when it was trading at 95.116 on the 2nd of May 2016. Since then, it has rallied as high as 94.290 on 10 May, but has since retreated to its current level of 93.809 (May 11, 2016). The US dollar index has a 1-year return of -4.89%, with a 52-week trading range of 91.919 on the low end and 100.510 on the high-end. The weakness currently exhibited by the US dollar index is indeed a mixed blessing depending on which side of the investment spectrum you’re standing. In India, equity investors are benefiting from dollar weakness as it means positive things for emerging market currencies. Over the past 3 months, the US dollar index has shed approximately 8%, approaching the 92 handle. Such has been the bullish sentiment associated with a weaker dollar that Indian equities have rallied by as much as 15% since February 2016.
It should be remembered that the performance of the USD is inversely correlated with equities and emerging market currencies. When the dollar is strong, the opposite is true of equities and EM currencies. However, in the case of India, the resilience of the local market has allowed the Indian rupee to remain relatively stable against the greenback, and with it equities markets too. As expectations of a Fed rate hike diminish, so the US dollar index weakens. This has a positive effect on the performance of emerging market currencies such as the Indian rupee, the South African rand, the Turkish lira, the Russian ruble, the Brazilian real and the Venezuelan bolivar. The likelihood of a rate hike in June is hovering around 8% according to the latest statistics, indicating that analysts do not foresee the Fed moving anytime soon. Instead, what we are seeing happening is a shift away from developed economies towards emerging markets, and India is front and centre in that regard. Spread betting traders at the leading online trading platforms have seen a big shift towards EM currency bulls of late.
Nigeria is staring down the barrel of a Forex crisis
Not all emerging market economies are as ebullient as India. Nigeria for example is facing a currency crisis of epic proportions and the country’s vice president reiterated as much in a recent address when he stated that a flexible approach is needed to be currency dilemma in the country. Nigeria is one of the biggest exporters of crude oil on the African continent, and the plunging price of the commodity has sent the country’s reserves into crisis mode. Even the IMF (International Monetary Fund) has been pushing for greater flexibility in the exchange rate. However, the president of Nigeria, Buhari does not believe that a further devaluation of the naira should be taking place. The Nigerian presidency has focused on a pegged exchange rate to the dollar of 197 – 199 for the past one year and two months. But the business community does not feel that the currency is worth that much and it is hurting the country’s export potential.