The US dollar continued its bullish rise in line with investors’ expectations and reached its highest peak in 14 years after the recent Federal Reserve’s meeting. On 15th Dec 2016, the US dollar index (DXY), which tracks the value of the US dollar against a basket of currencies of its major trading partners, soared to a 14-year high of 103.560.

While US investors rejoice over the bright prospects ahead, their counterparts overseas do not seem to share the jubilation. The strong greenback has exacted significant pressures on its major trading partners and led to a widespread capital flight. In this week’s #MarketMonday, we examine the strengthening US dollar and its impact on other currencies as well as explore what all these mean to investors.

Credits to Trump and Yellen

Arguably, the two major engines of growth of the US currency are Donald Trump’s proposed expansionary fiscal policies and Janet Yellen’s contractionary monetary policies. While their policies are seemingly contradictory and act as opposite forces to the growth of the US economy as discussed in last week’s #FeatureFriday, both contributed a significant push to the dollar in unison.

‘I will be the greatest jobs president that God has ever created,’ Trump pledged to create 25 million jobs over the next ten years.

Central in Trump’s grand scheme of expansionary economic plans, or Trumponomics, is both massive infrastructure spending and large corporate tax cuts. During his campaign, he promised to pump a trillion dollars into the local economy through government-led infrastructure projects. A businessman himself, Trump also took special focus on facilitating businesses in his home economy and planned to slash the corporate tax rate from 38% to 15%.

However, sceptical economists questioned these extravagant promises and have large reservations with regards to the feasibility of Trumponomics, in view of the rising US debt that Trump plans to mitigate with his very same policies.

Nevertheless, if Trump does honour his promises when he takes office next month, the fiscal stimulus might put US in a good stead in achieving the target growth of 3.5% per year, set out by the incoming president. As a result, consumer confidence has boosted considerably and investments are pouring into the US currencies and equities market, pushing the greenback to historical high.

The hike is also supported by the capital inflow after Federal Reserve announced its widely anticipated rate increase. While Yellen’s interest rates increase serve to mitigate the inflationary pressures set in place by Trump’s policies, also known as Trumpflation, the increase relative to other countries’ interest rates have made it more profitable to hold US currencies. In fact, Yellen hinted at 3 more rate hikes in 2017 and prompted a capital flight into the US currency market, sending the dollar index to its highest since 2003.

Capital Flight into US

The US bullish sentiments have attracted money from all around the world. Investors began withdrawing their funds and redirected their investments to the US currency. Consequently, Euro is one of the hardest hit currency as it drops to its lowest in 21 months. After Brexit, the Euro has been slowly recovering until Trump’s election success which saw the constant strengthening of the dollar and resulting weakening of the Euro.

Adding on to the rising Sino-US tension, the Yuan has also plunged to its lowest in 8.5 years which JP Morgan China Chief Economist, Haibin Zhu, attributed to the Fed rate hike.

The People’s Bank of China (PBOC), China’s central bank, have set Yuan’s mid-point rate at 6.9508 per dollar, an all-time low since May 2008. It reflects the severe capital outflow situation in China which surged up to $80 billion in November this year and more than $1.5 trillion since 2015.

Reacting to the sharp depreciation of the Yuan, Chinese are rushing to convert their money to foreign currencies. The US dollar became the natural choice. China Merchants Bank Co. reported that their most recently launched investment products that paid interest in US dollars were snapped up in exactly 60 seconds. This further exemplifies the severe capital outflow from China.

To curb the Yuan decline, the Chinese government has enforced rigorous regulations against moving capital out of the country. For instance, Chinese investors who desire to convert their Yuan to foreign currencies, have been restricted to a maximum of $50,000 a year. The government also imposed strict governmental checks on corporate transactions to further discourage Chinese corporations from purchasing assets from overseas. Furthermore, PBOC injected 250 billion Yuan into the market to plug the capital drain and other major Chinese banks are likely to follow suit and intervene.

Pegged Currencies Free-falling

Traditionally, many countries, including Hong Kong and several Middle Eastern countries have pegged their currencies to the US dollar to leverage on its strength and stability to create steady domestic economy growth. This robust US dollar appreciation however has put considerable pressure on the pegged currencies. To maintain the peg when the US dollar strengthens, these countries have to artificially create demand for their home currencies by buying it.

Yet there is a limit to government expenditure. Earlier this year, countries like Nigeria could not keep up with the US dollar and had no choice but to end their peg. The Nigerian currency, Naira, plummeted after the peg was ended. What follows was worse, the devalued currency resulted in higher inflation and larger capital outflow.

Speculations are rife about whether US pegged currencies such as Hong Kong dollars would be able to withstand the pressure and avoid a fate similar to Nigeria’s. Speculators are aggressively investing in forward contracts and forward rates for Hong Kong dollars just reached its highest peak in 2016.

However if Hong Kong dollars maintain its peg and strengthen against the devaluing Yuan, Hong Kong exports would lose its competitiveness to its major trading partner, China.

Singapore Dollar and Malaysian Ringgit Hit Hard

Besides the pegged currencies, other currencies are also under pressure and some have already been hit hard by the recent market turmoil.

The Malaysian Ringgit declined to the lowest in 18 years to 4.4805 per dollar. Analysts attributed the underperformance of the currency to Trumponomics and its central bank’s regulation to suppress transactions of non-deliverable forwards. Second Finance Minister Johari Abdul Ghani however is optimistic that the situation is short-lived and would improve.

Across the border, Singapore authorities are expecting a slowing economy and a depreciating Singapore dollar . The Monetary Authority of Singapore issued a statement explaining that the slowdown in its major trading partners, including China, have created a contagion effect in the Southeast Asian markets. In response to the Federal Reserve rate hikes, the Singapore dollar has already dropped to S$1.4481 per dollar.

Flee to Alternative Currencies

In light of such a situation, do investors only have the US currency to invest in?

Bloomberg analysts noted that alternative currencies such as the Bitcoin prove to be viable investments and “top all other currencies” this year.

Bitcoin’s value has escalated by 79% to $778 on the Bitstamp Price Index (BPI) in just this year. Worldwide restrictions on investment in foreign currencies, like the one in China, have prompted investors to invest in Bitcoin that is not restricted by the government. The US regulation against remittance of money overseas further augment the demand for Bitcoin that can be transacted across countries and not be limited by governmental control. These global events have subtly encouraged the usage and trading of alternative currencies and created substantial demand for Bitcoin.

In response, Bitcoin exchanges have also been sprouting in the global market. Earlier this year, Quoine, a bitcoin exchange based in Singapore raised $20 million and is seeking to facilitate global transactions with this up and coming currency.

While it might seem that the ever-strong US dollar is the only safe choice in the currency markets to invest your money in, investors can consider alternative currencies which might add another dimension of potential profit in light of all the restrictive regulations that forbid currencies exchanges.

 

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