Whether we consider the dollar’s level against a trade-weighted basket of other currencies or against a basket of commodities, its strength is arguably ‘the market story’ of 2022. As to why we have seen it move upwards in practically all dimensions, there are a host of explanations. There is the time-honoured dollar surge which happens with a hawkish shift in Fed policy. Another force lifting the $ is its perceived ‘safe-haven’ status – ‘safe-haven’ when there are concerns over global economic growth and/or geo-politics. Despite this dollar strength in 2022, one should be in no doubt what we have witnessed has been a dollar ‘head-fake’. Yes, the further the Fed raises its funds rate over the next few Federal Open Market Committee (FOMC) meetings, the wider the head-fake will prove, but in time – by mid-2023 – it will have proven to have been a head-fake nonetheless. Why? Well, a few reasons are outlined below.
De-dollarisation is well underway
As things stand today, the USD remains the currency used as the numeraire for trading in practically all commodities. However, profound change is upon us. Yes, as things stand, an element of commodity price weakness can be equated to dollar strength and a move higher in commodity prices can be attributed to dollar weakness. Yes, therefore, as things are today, given a weak dollar outlook, one should expect a general uptrend in commodity prices – but that is as long as they continue to be priced in the dollar. This is certain to soon change. Indeed, just one example is that we have recently learnt Ghana is in talks with Saudi’s Emirates National Oil for a barter arrangement that will enable it to buy oil with gold. This follows Chinese refiner Zhejiang Petroleum & Chemical signing a deal in November with Aramco to purchase crude oil in yuan. We have also learnt recently that China increased its gold reserves in November for the first time in more than three years, seeking to diversify its reserves away from the dollar.
Shattering the currency constellation of peggers
An element of the dollar’s strength comes not from its rise against currencies of developed nations, but against beleaguered fiats across the developing world. The reality is that with nation after nation soft-pegged to the dollar, the Fed’s policy tightening has and will continue to compromise the constellation of currencies which have been tied to the greenback. Central banks will realise their futures lie in trying to track against the RMB, not the USD. CFETS – the China Foreign Exchange Trade System – will continue to reduce all the more the dollar’s representation in the management of the RMB.
Does the HMKA really want to follow the FOMC in interest rate lockstep and suffer whiplash?
As things stand, the Hong Kong Monetary Authority’s (HKMA) rate management is to essentially follow the FOMC. And, since no small part of the dollar’s recent strength has been the prospect of ‘bungee-jump’ tightening – the violent whiplash of interest rates being lifted after a near vertical drop – the question is, should we expect Hong Kong equivalence? There has never been a more appropriate moment for the dollar of Hong Kong to break free monetarily from the shackles which have tied it to the greenback for close to 40 years. Break free, that is, by adopting a basket approach, one which – while continuing to include the US dollar – adds many other currencies in Hong Kong’s trading and commercial orb. With the FOMC continuing its policy of hawkish tightening into 2023, and the People’s Bank of China (PBOC) going the other way and continuing to loosen, the simple question is this: in which direction does Hong Kong go? To us, it is inconceivable the HKMA follows the FOMC in lockstep. If so, the dollar block will see its first ever voluntary defection – hardly auguring well for the dollar’s global standing.
A US hard landing while China re-emerges powerfully
As far as economic growth is concerned, the US faces such a challenging set of headwinds that it would be almost impossible to see it avoid toppling into a 70s-esque recession. Not least of these will be the harm done by the double whammy of ‘all too belated and thus all too elevated’ monetary tightening. For its part, China’s economic growth is primed to beat expectations; helped by its unlocking and the PBOC, which will continue to loosen fiscally and monetarily.
From cornerstone T-bill owners to sellers
What those disintermediating the dollar will do is ensure ever less buying and ever more selling of US Treasuries. And those doing so will not merely be the Chinese, but others who have hitherto been loyal owners and key buyers of US paper. No prior loyalist will become a turncoat more so than Japan, which has to begin redeeming its Treasuries, not least to fund its promised surge in defence spending.
The dollar is no resource currency
Something which has supported the dollar on its recent ascent is the conviction in currency markets that the dollar is a resource currency in a way the yen and euro most certainly are not. The idea here is that while Japan and the eurozone are in the midst of bleak energy and food winters, the US, with its varied energy sectors and sizeable tracts of arable land, has a great deal less to worry about. While this idea appears reasonable, it fails to allow for the fact that industrial US plays a key role in bringing in income from overseas. Whether because of a less competitive currency position hitting export transactions, or lowered levels of repatriation income, there are unwelcome consequences from the dollar’s rise against its main trade rivals and/or sources of overseas income. When these consequences show themselves – as indeed they have begun to do so since early October – sentiment that the dollar is a reliable resource currency will sour.
A truce in Ukraine
A sudden cessation of the conflict in Ukraine could – and will – further pull the rug from under the US dollar. We must remember too, the way Russian assets have been sequestrated since the most recent invasion of Ukraine has sent a clear message widely around the world: if you hold your wealth in traceable dollars, it could well be taken from you in the event you fall foul of Washington.
