Dollar Bulls Cling to History for Redemption After Wrong-Way Bet

History Shows U.S. Dollar Rally Is Not Over
  • Even with 2016 losses, currency seen in long-term bull run
  • Previous cycles suggest more gains in trade-weighted Fed index

The dollar’s worst quarter in more than three years has the currency’s backers boning up on their history to judge whether its long-term advance is finished.

The lessons of the past are encouraging. A trade-weighted dollar index from the Federal Reserve has had two previous sustained rallies in the past five decades, starting in 1979 and 1995. Each went on for longer, and produced bigger gains, than its 32 percent appreciation since mid-2011.

The previous advances lasted an average of 74 months and boosted the dollar by about 40-50 percent. Comparing that with the 57 months since the greenback started its latest spurt suggests to some the gains have at least another year to run. Even if the Fed is tightening policy slowly, the bulls say it’s still diverging from major peers that are committed to currency-weakening stimulus for some time to come.

“We wouldn’t toll the death knell for the greenback just yet,” said Steven Barrow, London-based head of Group-of-10 research at Standard Bank Group Ltd., whose first-quarter euro-dollar forecast was only about a cent off where the rate ended up. “We’d feel more confident in calling a top in the dollar if it had risen more to match prior cycles. The dollar’s uptrend has another year, or more, to go.”

Standard Bank predicts gains of 8 percent to $1.05 to the euro and 12 percent to 125 yen in the next 12 months, from $1.1388 and 111.20 as of 12:14 p.m. in New York. That’s more optimistic than the median estimates in Bloomberg surveys of $1.09 and 118 yen.

Wide Impact

Whether the dollar can sustain the gains of the past few years is the number-one debate in the foreign-exchange market in 2016. Many bulls have already capitulated, with others joining their ranks after the Fed signaled last month a slower pace of interest-rate increases. The dollar’s value affects virtually every walk of life in business and finance, from Chinese monetary policy and the price of commodities to company earnings.

QuickTake The Almighty Dollar

The dollar has had two previous bull runs since the Bretton Woods system of fixed exchange rates ended in 1971.

The first began in about August 1979, when Paul Volcker became Fed chairman and presided over a period of monetary tightening. The rally lasted until February 1985, shortly before the world’s richest nations signed the Plaza Accord, agreeing to intervene to weaken the dollar to help the U.S. economy out of a recession.

Bush Ambition

The second rally began around May 1995, when new U.S. Treasury Secretary Robert Rubin presided over an expanding domestic economy. The dollar’s gains topped out in January 2002 amid speculation President George W. Bush wanted a weaker exchange rate to boost exports and manufacturing.

This time around, the dollar hasn’t risen as much as in those previous cycles.

The Fed’s U.S. Trade-Weighted Major Currency Dollar index -- which tracks the greenback against a small group of peers including the euro, yen and pound -- climbed 39 percent from July 2011, when rich nations intervened to slow the yen’s appreciation, through to its peak this January.

That compares with gains of 54 percent and 41 percent in the runs starting in the 1970s and 1990s, data compiled by Bloomberg show. When the pullback since January is included, the current rally is smaller still.

Not the End

To Royal Bank of Scotland Group Plc strategist Mansoor Mohi-uddin, the dollar’s recent setback is reminiscent of what happened in the middle of the previous bull run, when the Fed cut interest rates in 1998 to deal with the fallout from the Asian crisis, only to resume raising them the following year.

“The dollar had about three to four years of outperformance afterward,” Singapore-based Mohi-uddin said. “I would argue that we’re in a similar situation to what we saw in the late 1990s, where the Fed was very worried about global financial markets. What we’re seeing now is just a pause rather than the end of a long-term uptrend.”

In 2010, Mohi-uddin correctly predicted the dollar would lose its haven status and start moving in line with higher-yielding assets such as stocks -- presaging the moves of the next five years, until the relationship was undermined by signals of an imminent rate increase.

Global Impact

The dollar’s prospects have significance beyond the U.S. economy. The vast majority of currencies measure themselves primarily against the dollar, and its value is critical to whether China stages a repeat of the yuan devaluation that has roiled global markets since August.

Major raw materials are priced in the U.S. currency, whose moves contributed to oil’s drop to a 12-year low in January -- and its pullback since. As much as central bankers insist they don’t target exchange rates, their currencies’ values relative to the dollar influence the performance of their economies.

The greenback dropped 4.6 percent against the euro in the first quarter, the most since 2011, tumbling from close to the highest level since 2003. It slid 6.4 percent versus the yen, the most since the wake of the global financial crisis.

These losses have led Pacific Investment Management Co. to conclude that the bulk of the dollar’s gains are over -- though it predicts a gradual rally rather than a decline.

“We have become more cautious,” said Thomas Kressin, Munich-based head of European foreign exchange at Pimco, which manages almost $1.5 trillion. “But I don’t think we’re about to see a reverse. The dollar is the least ugly among its G-10 peers.”

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