Before we drill down into the Fed policy decision, it is of significant importance that we look at the impact on the strong dollar on the US economy. Our research shows that between 1982 and 2000, the greenback soared nearly 178% and if you look at the performance of the country’s stock market, it skyrocketed nearly 1099%. During this period, the economy also created nearly 40 million jobs. On the flip side, during the decline of the dollar from 2001 to 2011, the job market printed a very abate number of 23 million jobs and the GDP growth averaged less than 2 percent as compared to the boom time when the same number was 3.5 percent.
The Federal reserve bank cannot solely look at their own economy when they want to raise the interest rate no matter how much you add noise to this statement. Yes, it is true that China only makes 1 percent of the US GDP, but no one knows the ripple effect of the debt which China is holding and if it starts to default what will be the consequences. Nonetheless, we concur that the base case for the Fed is economic data in order to raise the rates and this will matter the most. Given that the US non Farm payroll data has shown that the Fed has almost approached its full employment, there is nothing which warrants them to keep the interest rate this low – even if we plug in the Chinese weakness. For the Fed, it is the wage growth and participation rate, which is the most important and these two numbers are driving the dollar, which then makes the emerging market currencies bounce up and down. The below charts shows the US average hourly earning jumped to 0.3
It is true that the dollar strength is a negative sign for the emerging markets, but again, given the valuation and risk and reward ratio some of the opportunities are too good to ignore. The key to success is in choosing the correct currency among the emerging markets and see their fiscal and monetary policy and then place your bets accordingly.
There is no surprise if we are talking about a brawny currency amid emerging markets, the one which stands out is the Indian rupee. The Indian rupee is the only currency among emerging markets which has shown strength against the dollar during the past year. The currency had its biggest fall back in 2011 and 2013 when the major devaluation was taking place, but now, the question is if the currency will continue to shine through in the coming days. The authorities in India are taking remarkable measures to prop up its economy and sparking efforts are taking place at both ends- fiscal and monetary sides. India’s central bank governor, Raghuram Govind Rajan is considered as one of the most credible person among central bankers and he has recently said that there is only so much the monetary policy can do to shore up the economic growth and the rest of the weight must be taken up by the fiscal policies.
From this statement, we believe, that the governor is giving a clear message that the Indian central bank is pretty much done in devaluing the currency and its fiscal reform part is the responsibility of the country’s prime minister, Mr Mohdi. The prime minister is completely focused on making the country more friendly with international investments and this is feeding in the economic data. India’s dependence on China is very much limited, therefore, a slowdown in China is not meaningfully impacting the economic health of the country. In the past, with Greek debt crisis, which rattled the entire Eurozone and the global equity market, did not make much impact on the Indian rupee. This confirms that the currency may continue to outperform other emerging market currencies in the coming days. The below chart shows that the Indian rupee has started to consolidate against the dollar.
Although with Fed raising the rates, whenever that will take place will bring more volatility for the currency, but we do certainly believe that most of this already baked in the pair. The dollar may not soar by much as many are expecting, which will be perfect trader’s agenda “buy the rumor and sell the news”.
DISCLOSURE & DISCLAIMER: The above is for informational purposes only and NOT to be construed as specific trading advice. responsibility for trade decisions is solely with the reader.
by Naeem Aslam