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The U.S. Dollar is currently the most important macroeconomic variable.

 

Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html . For data vendor disclaimers refer to www.ndr.com/vendorinfo/ .

Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/.

The U.S. Dollar is currently the most important macroeconomic variable. For United States-based investors, the above statement may seem odd.  The value of exchange rates, especially the U.S. Dollar, is not something most think about.  That is because most of their assets, liabilities, income, and expenses are all denominated in the Dollar.  Outside of the U.S., this is not the case.  While most developed and emerging market countries have some version of their own exchangeable currency, most of their global trade is settled in the Dollar and 40% of global debt is Dollar denominated.  The simple take away from this set up is that when the U.S. Dollar is up, it is bad for the global economy.  As seen in the charts above, several of the Dollar indices have been increasing recently and several currency pairs are at record or multi-year lows compared to the Dollar. 

When the Dollar rises in value and access to its funding becomes more difficult, it places foreign governments and companies in a precarious position.  It becomes increasingly more expensive for them to settle debts, access credit and pay for imported goods, including those coming from outside the U.S. because they are settled in the Dollar.  When this occurs, foreign central banks can tap into the Dollar currency reserves to try and provide the Dollar funding to their banks/companies and support their domestic exchange rates.  This measure usually has a short lifespan as foreign central banks have a limited supply of Dollar reserves.  Eventually they must resort to raising domestic interest rates to try and increase their domestic exchange rate, or in some cases institute capital controls to prevent Dollars from exiting their banking system. These measures usually lead to a slowdown in credit formation and business activity, leading to a reduction in hiring and consumer spending. 

One area of the world where rising US Dollar pressures are being felt is Asia. This can be seen in the Asian Dollar Index ADXY  chart below. This index is near the lowest level it has been since 2005 and 10% from an all-time low.

Source: Bloomberg.

Source: Bloomberg.

From a U.S. perspective, the value of the Dollar can help investors forecast the likely path of U.S. monetary policy.  The Dollar can increase in value for a variety of reasons, some of which are ever-present advantages like high legal standards, free flowing capital markets, high liquidity, and easy convertibility.  More temporary changes in the value of the Dollar can be determined by differences in economic performance between the U.S. and other countries.  Another determining factor is the difference between real and nominal interest rates in the U.S. compared to other countries. 

Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html . For data vendor disclaimers refer to www.ndr.com/vendorinfo/ .

Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/.

Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html . For data vendor disclaimers refer to www.ndr.com/vendorinfo/ .

Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/.

This is likely the most important variable to watch for U.S. investors, as it is the one monetary policy makers have the most control over.  If the Dollar continues to appreciate, the expectation will be for U.S. monetary policy makers to lower interest rates (reduce the value and cost of financing the Dollar) and increase the supply and availability of the Dollar (likely through swap lines). 

This means that U.S. interest rates and global economic activity are likely to head lower until the Dollar declines.

 

Rank Dawson, CFA
Vice President, Investment Strategy

Boyd Watterson Asset Management, LLC

 

The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance.  The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.