RISK MANAGEMENT | 13 June 2023 What if the Dollar Weakens? Absa | Corporate and Investment Banking > Insights and Events > FX-Weak-dollar Mike Keenan Fixed Income and Currency Strategist, Absa CIB SHARE After months of strength, the mighty US dollar may soon weaken. What would that mean for foreign exchange (forex, or FX) and emerging market currencies? The US dollar had a bumper year in 2022. The nominal broad dollar index (a measure of the value of the dollar’s value against a basket of currencies) appreciated more than 12%, hitting a two-decade high in September. But many FX analysts expect the greenback to weaken in 2023. How might that happen, and what would it mean for global FX? To answer those questions, says Mike Keenan, Fixed Income and Currency Strategist at Absa CIB, one must first understand the drivers of that dollar strength. “The dollar has benefited tremendously from its interest rate advantage, especially against developed markets like Europe and Japan,” he says. “And it’s also benefited from being a safe-haven bid. When times are uncertain and tumultuous, people tend to buy safe-haven assets like treasuries and gold – both of which are denominated in dollars. It also has a good growth outlook compared with other developed markets, so it’s had a lot going for it.” Could the dollar weaken? But as the rules of life and markets dictate, nothing good can last forever. “Everyone has been ‘long dollars’, and no market can keep going in one direction because eventually everyone will have the same position,” Keenan explains. “The dollar could lose steam because of that positioning.” Then there’s the question of its interest rate and growth differentials. FX analysts are watching with interest to see how central banks treat policy going forward. “The market is saying the Fed [US Federal Reserve] is close to done with its hikes, while the European Central Bank is saying it might need to keep hiking,” says Keenan, “so some of the dollar’s interest rate advantage could start to wither. US economic growth is also under pressure – due to both the interest rate effect and the domestic bank turmoil – which may see credit markets becoming tighter.” Next year is a presidential election year in the US, and campaign trail antics are certain to make global headlines. But Keenan cautions against putting too much emphasis on domestic politics. “This is true for most currencies,” he says. “There’s a lot of hype when politicians are doing their thing, and that can certainly sway sentiment, but ultimately politics filters into the exchange rate through macroeconomic variables.” A weaker dollar’s impact on emerging markets A degree of What If? scenario planning around the US dollar can be useful for importers, exporters and corporate treasurers. What if the dollar does weaken? What would that mean for other currencies? “In general, a weaker dollar would be good for riskier assets and good for commodity-producing countries,” says Keenan. “Many emerging markets also have high levels of dollar-denominated debt, so if the dollar were to weaken their debt would become less burdensome to repay.” Coming back to the dollar’s safe-haven status, he says that a weaker dollar could be a sign that investors are ready to take on more risk. “If US investors are nervous, they’ll keep their money under the proverbial mattress in the States,” he explains. “But if they feel bulled up, they’ll be more comfortable going down the risk curve and investing in riskier assets. That would create an outflow of capital, and you’ll see emerging market currencies benefiting from investment flows and commodity-related flows. It also makes their fiscal fundamentals look better, especially if they have dollar-denominated debt.” Keenan warns, though, that a weaker dollar won’t necessarily mean a stronger rand. “The rand used to track the dollar tick for tick,” he says, “but that’s not been the case of late. Around November 2022 it decoupled from dollar movements – and that tells us that the rand is weakening for South African-specific factors. Factors like load shedding and greylisting have meant that we have not taken advantage of a weaker dollar environment. If the dollar does weaken, that’s by no means a guarantee that the rand is going to recover. Not if we still have these ongoing domestic issues at hand.” Mike KeenanFixed Income and Currency Strategist, Absa CIB https://cib.absa.africa/wp-content/uploads/2020/07/file_example_MP3_700KB.mp3 Related Articles RISK MANAGEMENT Why are 2 countries are taking 95% of Africa’s blockchain funding? 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