The US dollar's rally is indisputable. Even the perma-dollar bears have been silenced. However, judging from various media reports, the risk is in the other direction now. Many seem to be exaggerating the dollar's rise.
It is true on a bilateral basis the dollar is at multi-year highs. That is important for individual exposures. But to understand the impact on the US economy or on policy, nominal bilateral exchange rates are not sufficient.
What is needed is a broader measure and one adjusted for inflation. The Federal Reserve tracks precisely this in its real (adjusted for inflation) broad (comprehensive) trade-weighted dollar index. This should not be confused in any sense with the US Dollar Index (DXY), which is not based on trade flows (e.g., Mexico and China, two of the US largest trading partners are not included and it over-weights Europe).
This Great Graphic (from Bloomberg) shows the Fed's real broad trade-weighted measure of the dollar going back to 1980. It made its historical low in 2011, and by the end of last year had risen 12%. It moved above the 5-year (60-month) moving average (purple line) last July. It moved above the 10-year (120-month) moving average (green line) last November. Its long-term down trend (white line), however, has not been violated. Nor has this dollar measure risen above the 2009 high.
We think this chart gives reason to suspect that the dollar's advance is still in the early stages. We expect it to challenge the downtrend line, which comes in near 100 toward the end this year. At the same time, it is difficult to consider the dollar strong on a real broad trade-weighted measure at current levels. Given the relative closed nature of the US economy (exports plus imports as a percentage of GDP), the 12% appreciation of the dollar since 2011 is probably worth around 40 bp of tightening, which has been more than offset by other developments, such as asset purchases, lower interest rates, lower oil prices and rising stock market.
It is true on a bilateral basis the dollar is at multi-year highs. That is important for individual exposures. But to understand the impact on the US economy or on policy, nominal bilateral exchange rates are not sufficient.
What is needed is a broader measure and one adjusted for inflation. The Federal Reserve tracks precisely this in its real (adjusted for inflation) broad (comprehensive) trade-weighted dollar index. This should not be confused in any sense with the US Dollar Index (DXY), which is not based on trade flows (e.g., Mexico and China, two of the US largest trading partners are not included and it over-weights Europe).
This Great Graphic (from Bloomberg) shows the Fed's real broad trade-weighted measure of the dollar going back to 1980. It made its historical low in 2011, and by the end of last year had risen 12%. It moved above the 5-year (60-month) moving average (purple line) last July. It moved above the 10-year (120-month) moving average (green line) last November. Its long-term down trend (white line), however, has not been violated. Nor has this dollar measure risen above the 2009 high.
We think this chart gives reason to suspect that the dollar's advance is still in the early stages. We expect it to challenge the downtrend line, which comes in near 100 toward the end this year. At the same time, it is difficult to consider the dollar strong on a real broad trade-weighted measure at current levels. Given the relative closed nature of the US economy (exports plus imports as a percentage of GDP), the 12% appreciation of the dollar since 2011 is probably worth around 40 bp of tightening, which has been more than offset by other developments, such as asset purchases, lower interest rates, lower oil prices and rising stock market.
Great Graphic: Keep the Dollar Rally In Perspective
Reviewed by Marc Chandler
on
January 13, 2015
Rating:
Reviewed by Marc Chandler
on
January 13, 2015
Rating:
