For the Asia Pacific region the US Dollar is top of mind
The US trade-weighted USD basket is trading at all-time highs and USD, like an unchecked fire, has continued to draw oxygen out of the room with its steady grind higher this year. This, despite overall lower hedge fund positioning on dollar longs (CoT reports) as well as jawboning from Team Trump. Why has the dollar been so strong and market participants so wrong on the USD call this year?
In hindsight, a few factors come into view. It looks like they’ll remain relevant into Q4 and beyond:
- It’s a relative world, and the US has continued to outperform the rest of the world (RoW) economically. The US consumer continues to tick along, with an Aug ISM non-mfg. of 56.4 beating expectations of 54.0
- Despite starting to cut rates, the Fed still has by far the highest yielding central bank rate in the developed world, at a time when a host of other countries have been relentless with cuts (for instance, New Zealand’s 50 base point surprise cut in Q3 2019)
- Trump’s tariffs and international posturing is causing more pain for the rest of the world than it is for the US, thereby reinforcing the US outperformance of the RoW. His actions are strengthening USD, not weakening it
- The combination of US economic outperformance with still greater yielding assets makes a very strong case for asset allocation flows into the US – which is US dollar positive. The relatively slow economic growth outside of the US makes a case for international-facing US companies, and those based internationally, to focus on the US
- The bar for a weaker USD is quite high. We would need much more aggressive rate cuts from the Fed for RoW economies to start outperforming the US. We also perhaps may need some kind of Bretton Woods agreement, which looks unlikely given the high level of polarity in geopolitics
For the USD to structurally weaken other currencies must structurally strengthen.
Will the DollarYuan finish the year above or below 7.00?
Whether USDCNH closes above or below 7.00 by year end, as well as how it fares next year, likely comes down to one factor: Trump’s 2020 US Presidential Election strategy. Will he run as a deal maker and negotiator, seeking win/win terms with China and the likes of the Eurozone? Or will he run a tariff campaign, continuing the wave of escalation for another year?
The consensus seems to be on ‘the art of the deal’, but running on tariffs may make him come across as stronger to his voting base — as well as allowing him greater control of the news flow in 2020. Not to mention that he may be able to justify a bigger fiscal spend down the line if the economic headwinds from the tariffs continue. For now, there is no bear-term ceiling on the DollarYuan as long as Trump is on the attack.
In many ways, Trump is the best thing to have happened to China. Reforms and much-needed structural measures may have taken longer if there was less stress around the globe.
A pathway for USDCNH back below 7.00 would entail the US dropping trade tariffs and coming to a win/win agreement with China. That, plus a sustainable bounce in Chinese economic growth.
What currencies have been able to outperform vs. the USD?
Two of the top four currencies to have outperformed the USD YTD are Asian: the Thai Bhat and Indonesian Rupiah at roughly +8% in total return as of mid September. For Thailand, it has been a combination of a goldilocks environment with very tame inflation and decent growth. For Indonesia, it has been a combination of inflation being in check, favourable elections and a central bank that has been easing – drawing inflows to the local bond market.
On the flip side, Asia also has one of the worst performers against the USD YTD in the Korean Won. The KRW is down around -5% in total returns vs. the USD – but this is actually a tailwind for the export-heavy country, as its goods should be cheaper for USD buyers.