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The US Dollar: Where To From Here?

The Direction of the Dollar is a Key Question on Everyone's Mind: The strong dollar this past few years has been beneficial in some areas of the investment markets but has augmented pressures elsewhere. The key question that many investors and economists are asking is: with an upcoming interest rate rise in the US, is the dollar likely to strengthen further?

$ per €

History, however, suggests that the dollar is more likely than not to weaken following this expected initial rate rise in the US. If history repeats itself, heretofore poorly performing areas of the global markets - where the dollar has acted as a head wind - could be on the cusp of a recovery. Emerging and Asian equity markets, commodities, precious metals and the mining universe comes to mind.

As an example (see chart), the dollar is up 27% against the euro over the past two years, and there is a general consensus that the start of a rising interest rate cycle in the US will lead to further strength in the dollar.

But History Suggests Otherwise
The table below presents the last five major interest rate cycles in the US, and highlights where interest rates started and ended over each cycle. It also shows the performance of the dollar against a basket of other major currencies (the "Dollar Index") on a 1-month, 3-month, 6-month, 12-month basis and entirely over each cycle.

Interest Rate Upcycles Rates Went Dollar Index
Start End  From To    1  
Month  
Later   
3
Months
Later
6
Months
Later
12
Months
Later
Over
Whole
Cycle
                 
Mar-83 Aug-84 8.5% 11.5% -0.4% 0.9% 2.1% 1.9% 9.3%
Jan-87 Sep-89 5.8% 9.1% -0.6% -4.3% -1.1% -10.6% -6.1%
Feb-94 Jun-95 3.0% 6.0% -0.5% -0.5% -3.3% -5.8% -10.8%
Jun-99 Dec-00 4.8% 6.5% -2.0% -4.3% -3.7% 0.4% 3.5%
Jun-04 Aug-07 1.0% 5.3% 0.5% -2.4% -9.0% -2.3% -11.3%
Oct-15 ? 0.25% ? ? ? ? ? ?


What we can see immediately from the table is that on a 1-month, 3-month and 6-month view, the dollar has declined on four out of five occasions following the start of an upwards cycle in official interest rates. On a 12-month view and over the entire cycle, the dollar has declined three out of five times (and in the June '99 to December '00 cycle, the 12-month rise was just 0.4% and just 3.5% over the cycle).

Every cycle is different so we cannot tell the future, nor make any definite predictions. But it seems to us that the probability is high that today investors have already priced in the likely continuing interest rate differential between the US and other struggling developed economies.

Assuming dollar strength is behind us, several poorly performing assets classes might shine a little brighter in 2016 and beyond. For subscribers, we will be looking for confirmation of any reversal in trends among Emerging and Asian equity markets, commodities (and precious metals) and the mining universe. This is best done through 'Market Timing Indicators' - which highlight clearly when the trend is shifting - and we communicate these trends in our weekly newsletter that subscribers get on a Saturday.