The USD is slowly but surely regaining its supremacy. The USD index that tracks the USD against a basket of six major currencies is trading at over ten year high levels of 94. The Euro is down to levels last seen in 2005. Many emerging market currencies including India have hit record lows against the USD. Except for the Chinese Yuan that is up against the USD over the last few years, all other major developed and emerging market currencies are down against the USD.
The reason for the USD strength is the performance of the US economy relative to the rest of the world. US third quarter 2014 GDP printed at 5%, the highest growth rate seen since 2006. The economy has added over 2.5 million jobs in 2014 and unemployment rate is down to 5.8% as of November 2014 from 6.6% levels seen in January 2014. Inflation is staying below 2% levels, equities are at close to record highs and housing market is looking up.
US is importing less and less of oil as it produces more and more of oil. Read our Report of US Shale Oil Dynamics for trends in US oil production. US is likely to start exporting oil by 2018. Oil prices have dropped by close to 50% in 2014 and this drop benefits US the most as it is the worlds largest consumer of oil.
The implication of a strong USD are many. Developed countries such as the Eurozone and Japan benefit from strong USD as it helps exports. Oil and commodity dependent economies will face serious issues of inflation and recession as their economy goes into a downturn and their currency weakens substantially. Russia is a strong case in point. China would welcome a strong USD as it does not have to keep its currency artifically down to boost exports.
India benefits from a strong USD as it helps exports from IT and Pharma. However imports become expensive especially oil imports but given that oil prices are down sharply, a weaker INR will not really impact the country too badly. However it is imperative for policy makers to bring down fiscal and current account deficits and lower inflation expectations to keep the INR relatively stable against the USD. Read our Fixed Income Strategy Report for 2015 for analysis of India’s macros.
On an overall basis, a strong USD will cause huge shifts in financial markets with some benefitting at the cost of others. India does benefit if its macros are strong.
Currency Market Trends
USD has strengthened in 2014 as the USD Index gained 13% in 1 year and 18% in a 5 year time period. USD outlook is expected to be positive for the next one year as the Federal Reserve (Fed) is expected to increase interest rates, which they have kept at record lows over the last six years and the fact that other global central banks like ECB and BoJ are taking more stimulus measures to boost their economies and fight deflation. View on Presentation of Global Liquidity for analysis on Central Bank actions.
Euro declined 12% on a yearly basis and by 16% in a five year time period and is expected to remain weak at least in the first half of 2015 majorly due to contrasting monetary policy stance as ECB will take steps to boost economy in Eurozone and fight deflation whereas US is expected to raise interest rates. But in second half of 2015 the Euro may strengthen if Eurozone sees recovery.The ECB has announced an asset purchase program of Euro 1 trillion that will run until September 2016.
Currencies of commodity driven economies are expected to remain weak against USD as the commodity outlook is negative and Crude Oil prices are expected to follow a downward trajectory due to an expected global demand supply mismatch in 2015. OPEC’s recent decision to maintain its supply target of 30 million barrels per day would continue to put downward pressure on oil prices. The main beneficiaries would be the oil importing countries such as China and India.
Russian Ruble declined 44% in the last year against the USD and 49% in a 5 year time period. Ruble would continue to remain under pressure as the Russian economy is hugely dependent on export of oil and natural gas to generate half of its revenues. Sanctions over the Ukraine conflict would further put downward pressure on the Ruble.
Asian currency in 2015 are expected to follow mixed trend against the USD. Highly correlated currencies like South Korean Won and Taiwan Dollar will be affected by the JPY weakness as BoJ would take further measures to stimulate economy and fight deflation. China’s slowing economy is also expected to drive currency movement in the region.
South Korea and Japan are competitors in the international market as they compete in same product lines and weakness in Japanese Yen (JPY) will make South Korea’s exports uncompetitive, which will put downward pressure on the South Korean Won (KRW). South Korean Won (KRW) in 2014 has depreciated by 4.5% and has appreciated by 6% in a five year period.
Japanese Yen (JPY) declined 13% in the last one year against the USD and by 23% in a five year period. Uncertainty over the fiscal, economic and political outlook has added to the downward pressure on the JPY. Japan’s economic outlook remains challenging. Third quarter GDP data revealed that the economy is in recession with output declining by 0.4% q/q (-1.1% y/y) following a 1.9% q/q (-0.1% y/y) contraction in the April-June period.
On 31st October, the Bank of Japan (BoJ) decided to add monetary stimulus to the economy through its asset purchase program. It will expand the nation’s monetary base at an annual pace of 80 trillion Yen. Bank of Japan is expected to take further measure to keep inflationary expectations on a rising trajectory and to reaffirm the BoJ’s commitment to the 2% annual inflation target.
Prime Minister Shinzo Abe on 20th November dissolved parliament and called for an early election with an aim to renew his mandate from voters in order to postpone the second hike in the consumption tax rate (from 8% to 10%) scheduled for October 2015.
Japan’s government on 27th December approved stimulus spending package worth USD 29 billion (3.5 trillion yen). The package was unveiled two weeks after a huge election victory by Prime Minister Shinzo Abe. The government said that it expects the stimulus plan will increase Japan’s gross domestic product by 0.7%.
Chinese Yuan (CNY) declined 2.5% in the last one year against the USD, but has appreciated 10% in a five year time period. People’s Bank of China (PBoC) is taking steps to respond to the country’s slowing economic growth. On November 21st, the central bank lowered the benchmark lending and deposit rate by 40 and 25 basis points respectively to 5.6% and 2.75%. The lower lending rate should provide support to the economy. Yuan is expected to remain stable as record trade surplus is providing support to the currency.
Australlian Dollar (AUD) outlook for 2015 looks challenging as global glut is putting downward pressure on iron ore prices combined with weaker demand from China.
Australian Dollar (AUD) is trading at multi-year low levels as of beginning 2015 and in last one year period, the AUD has depreciated by 9.5% and by 10% in a five year period. The decline has been fundamentally driven on the back of falling iron ore prices, concerns over China’s economic outlook, and deceleration in several domestic drivers.
Australia which is world’s top exporter and producer of iron ore is heavily under pressure as iron ore prices is down by 49% in last one year. The decline in iron ore prices is attributed to the global glut and low demand from China. Outlook for iron ore looks challenging as Department of Industry in Australia is expecting average prices in 2015 would be around 63 USD/metric ton, down by 33% from previous forecast.
Indian Rupee (INR) declined 2% in last year and 26.5% in a 5 year time period. Rupee had touched record low level of Rs 68.85 against the USD on Aug 2013 when the economy was dealing with high inflation and wide current account deficit. In 2015, INR looks more stable against the USD due to improving macros and reform expectations that newly elected Modi led Government is expected to take. Inflation is down with CPI for the month of November reported at 4.38% and WPI at 0%. Fiscal deficit is also expected to remain at the Government targeted level. INR would also benefit from potential carry inflows due to its high yield.
USD is likely to stay strong in an uneven global economy and its strength is likely to cause deep shifts in global economic growth. Eurozone, Japan, South Korea and few other countries will benefit from USD strength while many other countries including Russia will face repercussions. China is a beneficiary of strong USD while India can benefit if its macros strengthen.