Illogical ? Counter-intuitive ? Perhaps, but historically Undeniable.....

Friday 14th August 2015

 

Illogical ? Counter-intuitive ? Perhaps, but historically Undeniable.....

 

Ref : "History Shows Time to Sell Dollar Is Now With Fed Near Lift-off" , Rachel Evans and Andrea Wong, Bloomberg Online

 

What's this ?? Surely it's one of the most basic truths that all other things being equal, a rise in rates strengthens the currency. So why is it that in the six month periods after the start of the last three rate-rising cycles in the US, the US$ has weakened by an average of 6% ?

 

The fact that the dollar had strengthened in the six to nine months prior to the first hike by an average of almost 9%  may ring a few bells. Remember the "buy on rumour, sell on fact" principle that we discussed earlier this week ? Fortuitously, this article offers a timely example of how that might work : traders putting on positions (in this case, long US$) in anticipation of a particular development (a rate hike) , only to unload the positions, hopefully at a profit, as soon as that development is confirmed.

 

Just like the examples of 1994, 1999 and 2004, we are now in the position of seeing a strong dollar in advance of a rate hike just around the corner, whether it be in September or December. To add fuel to the fire, the rate rises in those previous years were in each case the first in a series of aggressive hikes that should have provided even more dollar support, but didn't. This time, even if we don't know the exact timing of the move (September now looking 50/50), we do know one thing : the pace of further hikes will "gradual", "crawling" or "steady", to borrow the vocabulary used by officials. Frankly, after this week's events in China it's easy to make the case that the next move will be quite a long way off, and that the argument for buying dollars based on interest-rate differentials will be even weaker this time round.

So, it's a plausible scenario : the rate rise is already priced in and the dollar will be vulnerable "post-hike". We did signpost the possibility, but it nice to look at some examples from the past. Grab a look at the chart in the Bloomberg article if you can ..... it's instructive. Whether it means that what's happened before will happen again ..... ah now, that's another matter.