A popular measure of the dollar climbed to its highest level in more than 13 years, propelled by the expectation of rising US interest rates, the expectation of significant fiscal stimulus and concerns about the rise of populist forces in Europe.
The DXY, an index that measures the dollar against a basket of its main peers and primarily weighted to the euro, gathered pace on Wednesday, rising to 100.560, surpassing its previous high from early December last year, when comments from Federal Reserve chair Janet Yellen warmed up the market for a rate rise.
Although little information about future economic policy has emerged from the team behind president-elect Donald Trump since his election victory, market expectations that the US is headed for Reaganomics-style fiscal policy and monetary tightening continue to drive the dollar upwards.
Reflecting a sharp decline by the euro below $1.07, the dollar index has risen 2.8 per cent since election day in the US as investors have nearly priced in a 25 basis point rate tightening by the Fed next month.
The probability of a December rise, at about 60 per cent before the election, is now about 94 per cent, according to futures prices, while two-year Treasury yields have risen to 1.01 per cent, as the promise of looser fiscal policy spurs inflation and growth expectations.
The dollar is also pushing higher against the yen, poised to hit the Y110 mark for the first time since June, and has climbed to an eight-year high against the renminbi, while gaining appreciably against a host of emerging market currencies.
Its importance in the market is summed up by the Bank of International Settlements, which said this week that “the mantle of the barometer of risk appetite and leverage has slipped from the Vix [the highly watched CBOE Volatility Index], and has passed to the dollar”.
Three interrelated drivers are responsible for the dollar’s rise, said Marc Chandler of Brown Brothers Harriman: rate expectations, likely fiscal stimulus from the incoming Trump administration and “the rise of the populist right”, which is weighing on the euro ahead of next month’s Italian constitutional referendum and elections next year.
“The combination of these considerations and market positioning helps explains the persistence of some of the moves in the capital markets, including the strength of the dollar,” said Mr Chandler.
Economic data are underpinning what Brad Bechtel at Jefferies International calls the “Trump kicker” of promised tax cuts, deregulation and fiscal stimulus. October retail sales were stronger than expected, while producer prices held steady.
Such is the reserve currency’s rapid and stellar rise that analysts are starting to ask how much the new administration would tolerate a strong dollar. Comparing this move with the dollar surge ahead of last December’s rate rise, Mr Bechtel said the Fed and the markets became “very concerned and nervous about an extended and persistent rise in the US Dollar”.
The dollar spike proved debilitating for emerging markets currencies and threatened a negative feedback loop for the US economy.
The latest dollar rise is again worrying emerging markets, yet “no one seems as concerned on the general pace of the USD move”, said Mr Bechtel.
A very dovish Fed rate rise next month, accompanied by comments about the global factors and dollar strength, could shake out the dollar, he added.
Some analysts warn the dollar’s rally is looking stretched and the currency may be due a pullback. The DXY’s 14-day relative strength index, a closely watched momentum gauge, by midsession on Wednesday was 75.44, above the “overbought” threshold of 70.
Longer term, the consensus leans towards further dollar strength.
On the comparison with Reaganomics, Stephen Jen, chief executive at asset manager Eurizon SLJ Capital, said: “I’m not saying that there will be a repeat of the early-1980s, because the Fed is not going to be nearly as hawkish as [then] chair Paul Volcker was, but there are striking similarities between what policies Trump may have in mind and Reaganomics.’’
Additional reporting by Jamie Chisholm