The rising value of the U.S. dollar

Inna Mufteeva, US Economist at Natixis, on US economy and greenback

U.S. stock-index futures declined after equities climbed to a record last week, as Chinese trade data missed forecasts. Futures on the S&P 500 expiring this month fell 0.3%, whereas Dow Jones Industrial Average contracts slipped 0.3%. However, some analysts stay optimistic and believe that stock-index futures will continue to move higher into the year-end on the back of the strong economic numbers in the U.S. last week. Do you expect the analysts will prove to be right and what development do you anticipate further?

As for the economic development, I would mostly agree with the idea that it should remain rather positive and favourable for the US. The employment figures have proved to be solid and above expectations. The GDP growth is also expected to remain above its potential for the rest of the year and for the 2015. On the global scale, the prospects for growth as well as for productive investment, which is highly correlated with the performance of equity market, remain positive. Thus, if we look purely from the economic point of view, I expect the analysts to be right.

The rising value of the U.S. dollar, given the varying policies now being adopted by central banks, could have a significant (mostly negative) impact on the global economy and emerging markets, the Bank of International Settlements said in a Sunday report. In your opinion, what damages could appreciating Dollar bring to the global and domestic economy in the given situation?

The current situation around the greenback is somewhat special and it depends on a variety of factors. One of the most significant trends of the global economy at the moment is continuing oil price fall that partly offset the negative impact of the appreciating Dollar. Considering that US economy is not as open as Germany or China (exports represent only 12% of GDP), the impact of the raising Dollar on the US economy is probably quite limited, especially in the current environment, where the oil prices have decreased significantly. The drop of the latter has certainly given a boost to the US consumers, where the consumption represents around 70% of the GDP. Thus, the positive effect from oil is probably more important in terms of purchasing power boost for the US economy than the decrease in export, which a strengthening US currency can bring.

As for the global economy, for example the Euro zone where the Common Currency is depreciating quite sharply against the Dollar, it is still actually gaining in the competitiveness compared to the US.

Emerging markets will probably suffer more from the capital outflows. In the zones where structural problems exist already (China, Indonesia), the situation will probably be exacerbated by the fact that the Federal Reserve is likely to increase its interest rates soon.

However, we should not forget the global liquidity levels should remain high. The Bank of Japan keeps its QE program and the ECB is still thinking whether to increase its own one, and even start buying the sovereign bonds. These liquidity injections from the developed central banks will remain significant in 2015. I would not say that huge capital outflows will follow from the emerging markets whose fundamentals remain solid. I suppose, the markets where economic situations have already structurally being rather weak certainly will suffer the most.

What will be the major headwinds for the Greenback in the beginning of the upcoming year?

The major driver for the Dollar will be the anticipation of the Fed as well as the ECB policies that are based on the economic outlook for the respective zone. If we receive bad news on the economic prospects, then it will probably force markets to reintegrate new forecast for the Federal Reserve reaction. For now it has not really been the case, since the data remains positive, even though we had a couple of indicators, that disappointed slightly, such as ISM manufacturing. However, the latter stays on a very solid level, signaling the continuing the expansion of the US economy.

Disinflation may have a big influence on the US Dollar. Downward price pressures can be felt all over the world, especially in the Euro zone countries. Still, even in the United States the Fed starts to be quite concerned about the down tilt of the inflation expectations, especially on the survey based measures. The Fed follows the market based inflation expectations measures, but takes them less into account. What we need to see is a huge slide in inflation expectations of households, for the Fed to react and postpone its first hike. At this moment, all these pitches that we can witness from the US authorities show that monetary policy authorities are still rather comfortable with the scenario where they will hike Fed Funds rate in the middle of the year.

What are your forecasts for EUR/USD, USD/JPY and GBP/USD for the longer term perspective?

We forecast the EUR/USD to be at around 1.22 levels in three months and at 1.20 in six months. The USD/JPY we expect to see at 117 in March and at 119 in June. And talking about the GBP/USD currency pair, we can see it rolling up to 0.79 levels for both three and six months perspective.