Will the dollar beat its historical record?

16.12.2016 09:05|Conotoxia.com

Recently, the dollar reached its highest level in more than fifteen years. However, there are many factors which show that the American currency will continue to gain value. It’s possible that the dollar will exceed its historical record next year and will reach the level of approximately 4.70 PLN – claims Marcin Lipka, Cinkciarz.pl senior analyst.

Marcin Lipka, główny analityk Cinkciarz.pl

The condition of the emerging market currencies is dependent on its current, as well as estimated, economic condition. If perspectives for consumption, investment and employment are positive and there are chances for further improvement in these areas, we may expect a potential increase in interest rates which would decrease the risk of a business cycle overheating, as well as of too high inflation.

However, the exchange rates of the dollar (USD), the euro (EUR) or the pound (GBP) don’t move in a vacuum. They have always been expressed in relation to different currencies or to a certain currency basket. Therefore, the dollar’s value is not only a derivative of the American economic condition, but also refers to the macroeconomic situation in other countries. The larger the difference between the future economic growth and the expected level of interest rates, the larger the chance that the value of one currency will grow against the value of the other currency.

Dollar is growing stronger

Unemployment in the United States is at its lowest level in more than nine years (4.6%). This is also one-and-a-half percentage points below its fifty-year average. Inflation is slowly nearing its 2% goal and will likely reach this value in mid-2017. Moreover, American incomes, as well as the retail sales index, are also growing. This should revive investments.

Last year, the Federal Reserve increased interest rates for the first time since 2006. New rate hikes were made last Wednesday. Moreover, the Federal Reserve suggested that there may be three, instead of two, rate hikes in 2017, at 0.25 percentage points each. One of the reasons for this more restrictive approach towards the monetary policy, are the announcements of economic changes from the new American administration.

The fact that Donald Trump won the American elections, as well as the fact that Congress is dominated by the Republicans, can make it easier to implement Trump’s promises regarding economic changes from his presidential campaign. We are referencing the proposed changes such as an extreme decrease in taxes for entrepreneurs (from 35% to 15%), an increase in infrastructural expenses, a decrease in fiscal burdens for the wealthiest and a change in regulations for companies.

If this strong fiscal stimulation overlaps an already improving American business cycle and the increasing inflation, the Federal Reserve may not only sustain the perspective of three rate hikes for next year, but also increase the pace of monetary tightening. This information would be perfect for the dollar, because it would increase the difference between the interest rates of the United States and the interest rates of the other countries.

Other currencies are left behind

The economic situation outside of the United States is definitely worse. This translates to a mild monetary policy of the other developed markets. At the beginning of December, the European Central Bank extended the quantitative easing program until at least the end of 2017. Interest rates in the euro zone, Japan, Switzerland and Sweden are at a negative level and they most likely won’t be increased for many forthcoming quarters.

Therefore, the difference between interest rates in the USA and in the other developed markets is increasing. This week, the difference between the profitability of the American and the German two-year treasury bonds was above 2%. This was its highest level in approximately seventeen years. An estimated further improvement in the American business cycle supports the share market. Since the beginning of November, the main American stock market indexes increased by approximately 7% and reached their historical level. However, in order to benefit from the above trends, it is required to buy assets which are expressed in the dollar. The demand for the American currency causes its value to grow, and the supply of the other currencies causes a decrease of its exchange rate. The DXY index, which measures the value of the dollar against six developed market currencies (euro, yen, Canadian dollar, pound, Swedish krona and franc), increased to its highest level since the beginning of 2003.

It’s worth emphasizing that the strong dollar relatively has many negative consequences for the American economy. According to the data from the World Bank, the contribution of the American export against the American GDP, was at the level of 12.5% in 2015, whereas the same index was at the level of 31% for Canada, 45% for Sweden, 47% for Germany and 82% for Holland. Nevertheless, a high value of the dollar clearly improves the global purchasing power of the Americans. This will translate to their wealth level and may extend the period of relatively positive business cycle.

Impact of strong dollar on zloty

Since the implementation of the euro in 1999, the previously mentioned DXY index was only twice above its current level of 103 points. The first time was in mid-1999. However, the euro was at the level of 4.15 PLN and the dollar was at the level of 4.00 PLN at that time. What is worth emphasizing, is that the DXY increased more in the years 2000 and 2001 (17%), and went above the level of 120 points.

The second time that the DXY was near the level of 103 points was at the beginning of 2003. At that time, the euro was at the level of 4.00 PLN and the dollar was near the level of 3.85 PLN. Currently, the euro is at the level of 4.45 PLN and the dollar is at the level of 4.25 PLN. This goes to show, how weak the zloty is against the current level of the DXY.

The low value of the zloty is also indicated by its most objective index. Each month, the Bank of International Settlements (BIS) publishes the value of the zloty against the basket of currencies of Poland’s trading partners. This index includes inflation changes in Poland and abroad. At the end of November, the PLN REER was at the level of 87.25 points. This was its second lowest value in ten years. The last time the zloty was evaluated at such a low level was at the end of February 2009. This was the peak of the global financial crisis.

Taking into consideration the current trends within the Polish economy, as well as perspectives for the Polish monetary policy, it seems unlikely that the global evaluation of the zloty would improve. However, there is a large chance that the DXY will continue its growth. This is taking special consideration that the tendencies of differences, between interest rates for the dollar and for the other currencies, may continue to increase.

In conclusion, it is likely that the DXY will go above 11% in 2017. This is the similar level as in the first quarter of 2015. This scenario would not allow the zloty to gain globally. Moreover, the dollar may cost more than 4.70 PLN, which is its highest level in history.

 


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