There’s been so much coverage of plummeting oil prices lately that it has crowded out another major financial markets story of 2014—the rise of the U.S. dollar. The currency has gained more than 11 percent on the euro since May, and the trade-weighted U.S. dollar index has gained 20 percent since its low point in 2011. While that sounds significant, it’s actually a small move as dollar bull cycles go. The index, which measures the greenback against a basket of world currencies, gained 70 percent between 1978 and 1985 and 40 percent from 1995 to 2002. It remains to be seen whether the current rally has that kind of legs, but Credit Suisse believes the dollar’s rise will continue, to the tune of another 5 percent next year.
A key reason is monetary policy, as the Federal Reserve is widely expected to begin increasing interest rates next year. True, the market has already begun to price in a Fed hiking cycle. But Credit Suisse expects the central bank to be more hawkish in 2015 than the market does, forecasting the first hike in June and a total increase of 100 basis points during the year. All things being equal, higher U.S. yields will attract foreign capital and strengthen the currency. What’s more, the European Central Bank is expected to continue loosening its policy, potentially announcing more significant quantitative easing early next year, which bodes for further weakening of the euro against the dollar.
Credit Suisse also expects the U.S. economic recovery to continue next year, which should likewise attract more capital flows and strengthen the dollar. Recent economic data have been strong: the unemployment rate has fallen to 5.8 percent, while wage growth finally accelerated to 0.4 percent in November, signaling that employers are starting to give more raises and hire more from competitors. Consumer confidence in December rose for the fifth consecutive month to the highest level since 2007. All-in, Credit Suisse forecasts GDP growth to accelerate to 3.1 percent in 2015 from an estimated 2.3 percent in 2014.
History provides some guidance as to the implications for the market: global equities tend to perform well in times of a strong dollar. Since 1980,
equities have risen 72 percent of the time during years the dollar has strengthened, compared with 62 percent when it weakened, according to Credit Suisse. In particular, stocks of European companies that sell a large percentage of their products to the United States will benefit. Health care, pharmaceutical, and consumer staples stocks should see the most upside, according to Credit Suisse. By the same token, U.S. exporters in industrials and materials should perform poorly, as their products are becoming more expensive for foreign buyers.
The implications for emerging markets aren’t as encouraging. As we’ve already discussed, rising yields in the U.S. are causing heavy capital outflows from EM countries and weakening those currencies in the process. The declines are even more pronounced in oil-exporting countries such as Russia and Mexico because of the sharp drop in crude prices. A rising U.S. dollar will also crimp the ability of emerging market borrowers to pay off debts denominated in U.S. currency.
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