The Greenback is rising! The US Dollar is reaching levels last seen at the end of 2002. Even before Janet Yellen’s testimony to Congress this week, the market implied odds of an interest rate hike at the December 13-14th meeting rose to nearly 100%. The expectation of rising rates in the US, supported by increasing inflation expectations from a pro-growth/deficit-spend policy initiative from President-elect Trump, has buoyed the currency higher. An index which measures the value of the US Dollar versus a trade-weighted basket of currencies (index ticker DXY) shows the current index level up almost 25% since the end of 2014. How much farther can it go? Well, a simple look at the past can give a sense. The prior peak occurred in the middle of 2001 at a level almost 20% higher than where we stand today. The peak before that was at the end of 1984 nearly 50% higher than today; but recall that is when interest rates in the US were in the double-digits as then-Fed Chairman Paul Volcker combated an inflation problem. Granted, both of those peaks were relatively short-lived as the value of the US Dollar was either in rapid ascent/descent to/from the peak or settled into a middle range over the years between the spikes.
So the question is are we in a rapid ascent to a new peak, or just establishing a middle range higher than observed during the post-crisis period but more in-line with long-term history? Only time will tell. That aside, we can say that the relative strength of the US Dollar will create economic and financial market repercussions. A strengthening US Dollar that is associated with the expectation of a rising US economy tends to bode well for risk assets – especially stocks in cyclical industries. Naturally, for a US Dollar denominated investor, foreign holdings tend to under perform on a relative basis given the currency impact. Below is a table from one of our research providers which illustrates the historical experience. Economically speaking, a rising US Dollar coinciding with rising US interest rates would counter-balance the economic support that might come from pro-growth fiscal policy (not to mention whatever impact may be had based upon how trade deals are renegotiated). Bad comes with the good.