The U.S. dollar had its worst 2-week stretch of 2012 to start September. Here is the chart of DXY over the past 5 years, illustrating the dollar falling back into the middle of its 5 year range:
The recent weakness in the U.S. dollar has surprised me, particularly with regards to the Euro. My expectation for dollar strength was twofold:
1) I expected that easing action by the ECB would be more dovishly perceived than the action on the part of the Federal Reserve, particularly since the ECB’s actions would be a bigger change in overall stance vs. the previous 3 years. I was clearly wrong in that interpretation, as the ECB’s policies have been initially perceived as saving the Euro rather than weakening it
2) The Eurozone has been the less secure region in which to invest, whether in the bond market or the stock market. With deposit flows from European banks continuing apace (see FtAlphaville here for an assessment of the scale of the problem), I expected investor interest in the region to remain subdued. In retrospect, Europe outperformed all regions during the summer rally, aiding the Euro’s ascent.
However, the dollar weakness conveyed in the DXY index chart hides some of the differences among regions in terms of currency strength. Emerging market currencies that sold off severely in 2011 have failed to rally for the most part. Emerging market countries with high interest rates generally lead corporates in those countries to fund their businesses with dollar-based loans. When emerging market growth is strong, corporates taking out dollar loans in droves generally leads to dollar weakness vs. the domestic currency. But weak emerging market growth causes those same corporates to halt their expansion plans, and in some cases buy back dollars to appease their creditors.
Based on price action in emerging market currencies over the past year, it is clear that emerging market growth remains under pressure. Despite the recent bazookas employed by Draghi and Bernanke, emerging market currencies are closer to the bottom of their long-term ranges.
For example, here is 3 year chart of the Brazilan real vs. the U.S. dollar (higher on the chart means a higher dollar, lower real):
Brazil has been most dramatically affected by Chinese weakness among emerging markets. But even the Mexican peso, more tied to U.S. growth, or the Turkish lira, more tied to European and Middle Eastern growth, are not in the top half of their 3 year ranges:
The Mexican peso over the past 3 years vs. the dollar:
The Turkish lira over the past 3 years vs. the dollar:
One more broad conclusion I draw from these charts – investors across the world still view the prospects for U.S. growth as most favorable of the 3 major regions (U.S., Europe, and China) over the coming months (based on the Mexican peso’s relative strength).