Stable Dollar Keeps Global Markets From Blowout
Thu Apr 19 05:06:00 2018
By Mike Bird
While investors have fretted that stocks and credit are overvalued this year, in one market prices may be at their most balanced in years: currencies.
Volatility returned with a bang to global stocks this year, interrupting a bull market than began almost a decade ago and raising investor concerns about the durability of a yearslong rally.
In comparison, major currencies have been tranquil.
Some analysts and investors say the upheaval in equities could have been even more substantial, spreading to debt markets too, if it weren't for the stability and lack of distortions in exchange rates.
Several major currencies have closed in on their fair-value levels, estimates of where they should trade based on the economic fundamentals of different countries.
"Getting closer to fair value means the risk of major swings in the future is reduced, and the market seems to be fairly relaxed around these levels," said Ugo Lancioni, head of global currency and portfolio manager at asset-management firm Neuberger Berman.
"In global markets, volatility can spill over from one market to another, so stable currencies do limit concerns in a way," added Mr. Lancioni. "These could be the levels that make everyone happy, at least for now."
Currencies in some emerging markets -- such as Russia and Turkey -- have experienced sharp increases in volatility. But for now, those cases are the exception rather than the rule, especially compared with the currencies of advanced economies.
The weaker dollar may also reduce the chance of rapid shifts in exchange rates.
The yen, euro and British pound were steeply undervalued against the U.S. dollar in recent years. But much or all of that gap has been closed, according to the most recent fair-value estimates -- known as fundamental equilibrium exchange rates -- compiled by the Peterson Institute for International Economics. The approximations are based on the balance of payments between different countries.
President Donald Trump accused the Chinese government of "playing the Currency Devaluation game" on Twitter this week. But even the yuan is now almost exactly where the institute's November estimate suggested it should be.
Likewise, the International Monetary Fund suggested the U.S. dollar was 10% to 20% overvalued in its last assessment, which ran to the end of 2016. Since then, the United States Dollar Index has declined around 13%.
Even as volatility has climbed in stocks, it has remained low in currency markets, particularly the most traded pairs. Cboe's volatility indexes tracking the euro and yen exchange rates with the dollar are lower than they have been around 90% of the time since 2007.
"When the currency is trading outside a reasonable valuation range, it can pull back like a magnet to that area quite quickly," said Steven Saywell, senior multiasset specialist at BNP Paribas.
Even analysts who believe fair value is still some way off suggest currency markets have moved closer to reasonable levels. Mr. Saywell argues that over the longer term the euro should be close to $1.34, and the dollar closer to 80 to the yen.
"We haven't traded near fair value in quite a long time. So we believe what's happening now, as the disparity between the U.S. and the rest of the world is narrowing, we're moving back towards equilibrium," Mr. Saywell said.
Lower volatility in currency markets tends to support global flows of capital. When volatility in foreign-exchange markets rises, investors tend to cut their purchases of international equities, according to recent research by Valentyna Ozimkovska at the University of Kiel in Germany.
The strength of the greenback also matters.
A weaker dollar is linked to stronger cross-border bank lending in dollars, according to research published by the Bank for International Settlements earlier this year. The working paper also concluded that investment in a country declines when its currency depreciates against the dollar.
The impact of the dollar's strength on global financial conditions hasn't gone unnoticed by policy makers, according to some analysts.
"The most important development which has happened over the last three years is what's happened at the Fed. They've internalized the idea that the U.S. affects the rest of the world more through the financial conditions channel than the trade channel."
For Karthik Sankaran, director of global strategy at Eurasia Group, the fact that the dollar has failed to rally this year has been a factor protecting stocks from an even steeper selloff, and preventing a sharper reaction in the bond market.
"That's one of the reasons why you haven't seen more sustained selloffs in the market," he said.
To be sure, not all market watchers see the lack of movement in the dollar and the absence of foreign-exchange volatility as benign.
"It's not because there are no worries -- it's because you've got these countervailing worries that are both so powerful," said Ben Hunt, chief investment strategist at Salient Partners LP.
"You've got a Federal Reserve that's been very clear they're on a path and are going to stick to the path of raising rates," Mr. Hunt said. "At the same time there's no way you can be long the dollar with Donald Trump in the White House. There's just no way."
Write to Mike Bird at
Mike.Bird@wsj.com
(END) Dow Jones Newswires
April 19, 2018 05:06 ET (09:06 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.
