Investors might want to watch their dollar weight

12 Feb 2018 02:45 PM

The mighty greenback is not as mighty as it was; the US dollar plunged in value to lose almost a tenth of its value last year, measured against a basket of global currencies.

That is the dollar’s first decline in five years and its biggest annual fall since 2003 when it tumbled almost 15 per cent, according to the ICE dollar index. This year has also been pretty bumpy, at least so far.

This matters to UAE residents, because the dirham is pegged to the dollar. When the dollar falls, so does the value of your dirham earnings, relative to other currencies.

As far as your local spending goes, this is not much of a problem. While the dollar’s reduced international purchasing power may drive up the cost of some imports, the local effect should be minimal.

However, it will cause pain for UAE residents with financial commitments overseas, such as a mortgage in a foreign currency, as repayments have risen sharply in dollar terms. Also, any foreign investments that are priced in dollars will also be worth relatively less than they were before.

Last year's sharp plunge in the value of US currency has been given a name: the “dollar dump”. So why are people dumping it, and where does it go next?

Gaurav Kashyap, market strategist at Equiti Global Markets in Dubai and a columnist for The National, says recent dollar slippage follows several years when the greenback was all conquering. "The US Federal Reserve was the first central bank in the G7 to start hiking interest rates after almost a decade of ultra-loose monetary policy, with the first increase in December 2015."

The Fed hiked rates three times last year, with the final increase in December lifting them by a quarter of a percentage point to a range between 1.25 per cent and 1.50 per cent. There are more hikes to come, with the Fed forecasting three additional rate increases in 2018 and 2019.

Higher interest rates normally bolster a currency, as they attract more global money as investors pour in looking for a higher rate of return on their money. However, the effect is now wearing off, even though US interest rates are now higher than in other major economies. For example, they stand at zero per cent in the euro zone and 0.5 per cent in the UK.

Mr Kashyap says that now it is clear the United States is on a track to normalise rates, restless investors are shifting attention to countries yet to take action. “Markets are focusing on the European Central Bank and the Bank of England, in anticipation of when they will increase rates. Both have become more hawkish with their rhetoric and this has greatly contributed to dollar weakness.”

Markets expect the ECB to increase interest rates later this year. The BoE hiked rates in November last year, and analysts are assuming it will increase them again in May, to 0.75 per cent.

As a result, both the euro and sterling have put on some muscle. At time of writing, one dollar will buy €0.82, down from €0.95 at the start of 2017, which marks a sharp drop of almost 14 per cent over the period.

That's how aggressive the dollar dump has been, especially against the euro, which has been bolstered by Europe's recent rapid economic recovery.

Over the same period, the dollar’s buying power has slumped from £0.81 to £0.72, a drop of more than 11 per cent, despite the ongoing political and economic trauma of Brexit.

Mr Kashyap says the US is suffering political uncertainty of its own, with Washington in gridlock and the government divided. “It is also quite clear that the Trump administration is targeting a weaker US dollar, in a bid to make exports more attractive.”

With US stock markets widely seen as overvalued and now selling off, further trauma for dollar earners is to be expected, he adds.

However, there is no need for expat dirham earners to panic. “Currencies move in cycles and should ultimately balance out as far as your long-term investments are concerned.”


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