The decline in the US dollar is a boon for risk assets around the world

NEW YORK, July 14 (Reuters) – Slowing inflation in the United States has accelerated the dollar’s decline, and risky assets around the world are expected to benefit.

The dollar is down nearly 13% against a basket of currencies from a two-decade high last year and stands at a 15-month low. Its decline accelerated after the US reported lower-than-expected inflation data on Wednesday, supporting views that the Federal Reserve is nearing the end of its rate-raising cycle.

Because the dollar is the backbone of the global financial system, a wide range of assets will benefit if it continues to decline.

A weaker dollar could be a boon for some US companies, as a weaker currency makes exports more competitive abroad and makes it cheaper for multinational companies to convert foreign earnings into dollars.

An analysis of the Russell 1000 by Bespoke Investment Group shows that the US technology sector, which includes some of the large growth companies that have led markets higher this year, generates just over 50% of its revenue overseas.

Raw materials, which are priced in dollars, become more affordable to foreign buyers when the dollar falls. The S&P/Goldman Sachs (.SPGSCI) commodities index rose 4.6% this month, in pace for its best month since October.

Emerging markets also benefit, because a lower greenback makes dollar-denominated debt easier to service. The MSCI International Emerging Markets Currency Index (.MIEM00000CUS) is up 2.4% this year.

“For the markets, the weakness of the dollar and its primary driver, which is weaker inflation, is a solution to everything, especially for assets outside the US,” said Alves Marino, foreign exchange analyst at Credit Suisse.

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The greenback’s decline came as US Treasury yields have fallen in recent days, dampening the dollar’s appeal while boosting a wide range of other currencies, from the Japanese yen to the Mexican peso.

“That sound you’re hearing is technical levels breaking across the foreign exchange markets,” said Karl Schamotta, chief market strategist at Corpay. “The dollar is trending towards levels that were seen before the Fed started to rally, and we see risk-sensitive currencies rallying on a global basis.”

A continued decline in the value of the dollar can increase the profits of foreign exchange strategies such as dollar-funded carry trades, which involve selling dollars to buy a higher-yielding currency, allowing the investor to cash in the difference.

The dollar’s decline has already made the strategy profitable this year: An investor who sells dollars and buys Colombian pesos would have accumulated 25% year-to-date, while the Polish zloty has made a 13% return, data from Corpay showed.

Paresh Upadhyaya, director of fixed income and currency strategy at Amundi US, is bearish on the dollar while betting on gains in the Kazakh tenge, Uruguayan peso and Indian rupee.

“When you look at what’s happening now, the outlook for the dollar remains very bleak,” said Upadhyaya, who expects carry trades to boom if the dollar continues to decline.

Reuters graphics

In the realm of monetary policy, the dollar’s decline may come as a relief to some countries, as it removes the urgent need to prop up their falling currencies.

Among them is Japan. The US currency has fallen 3% against the yen this week and is on track for its biggest weekly decline against the Japanese currency since January. The weaker yen has been problematic for Japan’s import-dependent economy and raised expectations that Japan will again intervene in the markets to support its currency after doing so for the first time since 1998 last year.

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Traders were also wary of possible action from the Riksbank given the weakness of the Swedish Krona. But this week, the dollar is down nearly 6% against the krona and is heading for its biggest weekly decline since November.

Kenneth Brooks, a currency strategist at Societe Generale, said that the continued strength of the yen may lead to investors abandoning the large bearish positions that have accumulated against the currency in recent months, which will push it higher.

Of course, the dollar being bearish has its own risks. One is a potential rebound in US inflation, which could fuel bets for more Fed tightening and resolve many of the anti-dollar trades that have boomed this year.

Although inflation has slowed, the US economy has remained resilient compared to other countries, and few believe the Federal Reserve will cut interest rates anytime soon, which could limit the dollar’s downside in the near term.

However, Helen Geffen, foreign exchange trader at Monex USA, believes that the Fed will end the rate hike cycle before most other central banks, reducing the dollar’s long-term momentum.

She said that while the dollar may limit some of its recent losses, “looking at six months the dollar is likely to be weaker than it is today.”

(Narrated by Saqib Iqbal Ahmad). Additional reporting by Dara Ranasinghe and Ira Iosbashvili; Writing by Ira Usbashvili; Editing by Leslie Adler

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