The dollar remains the world's dominant reserve currency

PERSPECTIVE

The all-conquering Dollar. Over the past 12 months we have seen multiple reports of the imminent decline in the dollar. A collection of emerging market countries who call themselves ‘BRICS’ have vowed to end the dominance of the dollar as the world’s reserve currency. This pattern has repeated itself throughout history with GBP, JPY, CHF, EUR and now CNY all being touted as a viable alternative to knock USD off its throne. As the dollar index retreated from its highs of 115 in August 2022 down to below 100, it looked as though the dollar was losing significant ground in valuation terms in ways that some would see (yet again) as evidence of a diminishing role in structural terms. The fact remains, however, that there is no viable alternative in the market. This is backed up by the recent surge in the dollar index that has come as a result of a worsening global economic and geopolitical picture, with dollar-denominated holdings reprising their perennial role as a safe haven in times of trouble. The DXY is now back trading above 106; prior to 2022 these levels were last seen in the early 2000s. If you look back through recent history, it is clear to see the dominance of the dollar isn’t just holding but gaining momentum. In times of crisis, markets only see one place to rush to, and that tells you all you need to know.

US DOLLAR

• The past week we saw the US Dollar Index appreciate by a touch over 0.4% against a trade weighted basket of its peers. Data released last week showed the US economy is still extremely resistant to the record interest rate hikes of the past 18 months. The main data release of the week was the Q3 GDP Growth Rate which came in at a whopping 4.9% vs 1.7% as forecasted. This was supported by strong activity PMIs early in the week and an equally bumper Durable Goods Orders print.

• Later in the week, we saw a slight pullback in the dollar upon the release of the FED’s preferred measure of inflation – the PCE Price Index. We saw a marked drop in Core PCE prices down to 2.4% QoQ, down from 3.7% the previous quarter. If sustained, this would give monetary policy makers more room to lower interest rates.

• On Friday, we saw the main reason behind the larger than expected GDP print with monthly growth in personal spending coming in at 0.7%, vs 0.5% expected. One point to note is that personal income came in lower than forecasted. This is perhaps the reason why the dollar didn’t appreciate as much as expected on the GDP Growth Data.

• There are clear signs that economic activity in the US is reaching its peak. Market participants are forecasting a slowdown from a strong third quarter as the US economy is set to run into a number of headwinds. The effect of interest rate hikes in 2022 are set to take hold of the economy (it typically takes 12-18 months for the effect of a rate change to be fully felt by the economy). Also, we are seeing mounting consumer credit card debt, giving a strong indication that the huge stockpile of savings from the pandemic have been all but eroded.

• The FED heads into its monetary policy meeting on Wednesday in a much more cautious mood. Recent comments from FED Governors have led markets to completely price out a rate hike for this coming meeting. Markets will be mainly focusing on FED Chair Powell´s press conference after. He is set to respond to questions around the potential upcoming negative effects of geopolitical drivers, union workers strikes and the FED’s thoughts on future growth expectations given that he has acknowledged that more recent interest rate hikes have yet to take full effect. We are likely to see large volatility in FED futures surrounding the press conference as markets price in the direction of FED interest rates.

• Looking further ahead, a confounding factor for the FED may be the implications of rising bond yields. The yield on 10-year US government bonds has risen to 4.9%, a level last reached in 2007. This has been caused by factors including fiscal imbalances in the US and tight monetary policy, but the crucial difference between now and 2007 is that government debt is higher, meaning that the total interest cost is higher: it was 1.3% of GDP a decade ago, it will be 2.5% of GDP this year, and it will be 3.2% of GDP by 2030 on current projections. This could be resolved with modest tax increases if US politics were not so dysfunctional. More likely it will be deficit-financed, giving the FED a tradeoff between keeping interest rates high to offset the effect of enlarged fiscal deficits (which are inflationary if the economy is running at or near full capacity) or lowering them to ease pressure on the budget. They will almost certainly choose the former (leaving managing the budget to Congress, as they are meant to) so there is a limit on how low we can expect rates to go after the current tightening cycle is over.

ASIA-PACIFIC

• In China we saw the exchange rate hold steady against the dollar, once again, to end the week trading just above 7.31. There were no data releases of note out of China last week. The economy is still grappling with the fall out effects of a deepening property crisis, with further real estate developers either defaulting or set to default on their international loans. China’s local government debt supply surged once again in October to a new record high, and the central government instructed banks to set artificially soft rollover and interest rate terms for these exposures, pointing to another source of strain on the financial system, which is already struggling with dubious small business loans. The situation has been exacerbated by a huge decrease in foreign direct investment, as the world’s second-largest economy continues to struggle to convince markets of its stability. Following last week’s stronger than expected GDP release, CNY holders would be hoping for a strong activity PMIs as set to be released this week to help support the economy and its currency.

• The Chinese government announced a stimulus package that will involve increasing the fiscal deficit from 2.9% to 3.8% of GDP, an additional $137bn worth of bond issuance and expenditure that will be spent on improving flood defenses around the country – a classic example of kind of public spending that works well for fiscal stimulus measures. This is a larger stimulus than expected and President Xi has shown his direct interest in the policy by appointing a new finance minister and visiting the central bank – signals of intent that are likely to aid the effectiveness of stimulus in China’s authoritarian system. Whether this is enough to reinvigorate growth remains to be seen, and it does little to address the various bad debts festering on the banking sector’s balance sheets. Look out for further government interventions.

• The Yen saw its first weekly gain against the dollar in three weeks to finish the week trading a touch weaker than 149.5 vs USD. We saw further declines in manufacturing and services but a small gain in CPI. The BoJ heads into its monetary policy meeting on Tuesday facing severe currency depreciation, below trend growth and widening interest rate differentials in comparison to its G10 counterparts. The BoJ is set to announce the winding down of its unconventional yield curve control policy as it looks to move towards tighter monetary policy to help support its ailing currency. Indeed, there are reports that the BoJ could scrap the yield curve control policy in its entirety. Governor Ueda has noted that the wage growth is beginning to push up consumer prices, leaving room for tighter policy.

• The Aussie appreciated vs the dollar once again last week but is still trading below 0.64 against USD. Data releases showed a contraction in manufacturing and services but there was an upside surprise in inflation compared to forecasts. In last week’s monetary policy report, released by the RBA, it was noted that further policy tightening might be required if inflation persists. Headline inflation at 5.4% is still far from the Central Bank’s target of 2%, leading to markets revising upwards expectations of future hikes. Also, helping to supporting AUD have been signs of potential recovery from its major trading partner, China, following its larger than forecast GDP print the week previous. Talks of an Australia-EU free trade deal dissipated shortly after last week’s G7 summit as they failed to reach an agreement. With China struggling further signs of a trade deal between the two trading partners would help provide support to the currency and the overall economy.

SOUTH ASIA

• INR remained steady slightly weaker than 83 vs USD last week as the Indian economy appears to be in good health. There were no data releases of note from India last week.

• PKR depreciated by just under 1% against USD last week, ending the week trading at 280.35. There we no data releases of note as markets look ahead to the central bank interest rate decision on 30th October, market forecasts have now been revised down with rates expected to stay steady at 22% having previously priced in a hike up to 23.5%.

MIDDLE EAST AND AFRICA

• Nigerian Naira continues to tumble, experiencing record falls and reaching record lows against the dollar. New President Tinubu took office in May with the pledge to attract foreign investment to Nigeria, allowing the Naira to float more freely. Since then, the float of the currency has had to be managed by the Central Bank due to capital flight fears. Reports of severe dollar shortages on the ground are increasing as the gap between the official and the parallel market rate has widened once again. The unofficial rate reportedly touched an all-time high of 1290 Naira to the dollar last Friday. It is clear the government needs to set a clear plan to attract dollars to the country before the currency can be fully floated. As things stand there is far too much demand for the supply of USD available in the market. A volatile period ahead looks all but certain for the Naira.

• The Kenyan Shilling posted another weekly decline of 0.4% against USD, continuing a long-running trend. There were no data releases of note last week as the economy continues to struggle with dollar shortages.

• The Tanzanian Shilling remained steady at 2500 against USD as the central bank and government continue to take measures to address Dollar shortages. There was no major market moving news this week from Tanzania.

• South African Rand appreciated by 0.8% to trade a touch below 19 Rand to USD. Last week was light for data other than a hotter than expected PPI print, coming it at a 1.5% month on month increase. The central bank has its interest rate decision next month and will be watching closely for further signs of inflationary pressures as chances of a hike are being revised upwards by market participants.

EUROPE

• Heading into rate decision week for the BoE, GBP posted yet another loss, ending the week trading 0.3% lower at 1.211 against USD. Reports suggest rates are expected to remain at 5.25% as the UK continues to struggle with elevated levels of inflation. This comes in a context where recent evidence shows weakened economic activity and growth. Indeed, last week we saw further contraction in manufacturing and services as the economy is beginning to show signs of a slowdown driven by heightened interest rate levels. The major market mover for GBP this week will be the central bank’s forecasts for the UK economy. Earlier in the year, growth forecasts were revised upwards due to a strong labour market and consumer spending. Market participants will have a keen eye on the BoE’s forecasts before they make their predictions on future rate expectations.

• The Euro dipped back below 1.06 against the dollar last week following the decision to hold rates at 4% in Thursday’s ECB monetary policy meeting. Data from the manufacturing and services sectors were underwhelming once again, showing contraction in October. President Lagarde reinforced, in her speech following the rate decision, that inflation remains too high and the door is still open for further rate increases. However, markets were unconvinced of any hawkish intent by the central bank, based on the continued worsening of activity and growth data, which leaves little room for further tightening. The ECB has a tough road ahead when it comes to the balancing act of growth against price stability, as it tries to find a solution which works for all its member states. A rebound in economic activity from China would certainly lend support to the struggling trading bloc. At the moment, however, it is hard to make a case for Euro strength in the near term.

OTHER NEWS

• The Rouble appreciated to 92 against USD as the central bank hiked rates to 15%. Russia recently implemented capital controls to help support its declining currency in the face of spiraling inflation and capital flight. Russia’s GDP growth turned negative in 2022, but the IMF projects that it will run at 2.2% this year, and the armaments sector (which the government regards as a central priority) has managed to maintain production of missiles and other outputs despite Western sanctions on high-tech components. Higher interest rates may take their toll, but the new policy package may prove sustainable.

• Equities have dropped globally as the effects of elevated interest rates worldwide have hit economic activity, and geopolitical turmoil has added to adverse expectations. The US S&P 500 has dropped over 10% from its July peak.

• Crypto prices have rebounded on news that the SEC will not fight a landmark ruling allowing a Bitcoin exchange traded fund. Bitcoin now trades over 30% above its September lows.

PERFORMANCES AGAINST US DOLLAR

Information as of 2023 October 30th 09.00 UAE time.

THE WEEK AHEAD

Monday, Oct 30th ·

• EU Economic Sentiment

• US Dallas Fed Manufacturing Index

Tuesday, Oct 31st

• Japan Unemployment Rate

• Japan Retail Sales

• China NBS Manufacturing PMI

• Japan BoJ Interest Rate Decision

• EU GDP Growth Rate

• EU Inflation Rate

• Canada GDP

• US House Price Index

Wednesday, Nov 1st

• China Caixin Manufacturing PMI

• UK Nationwide Housing Prices

• UK S&P Global/CIPS Manufacturing PMI

• US S&P Global Manufacturing PMI

• US JOLTs Job Openings

• US Fed Interest Rate Decision

Thursday, Nov 2nd

• EU HCOB Manufacturing PMI Final

• UK BoE Interest Rate Decision

• US Factory Orders

Friday, Nov 3rd

• Australia Retail Sales

• UK S&P Global/ CIPS Composite PMI

• EU Unemployment Rate

• Canada Unemployment Rate

• US Non-Farm Payrolls