The US dollar has risen sharply in October. The appreciation of US dollar can mainly because of the expectation of US rate hike in this year. Is there any room for US dollar further appreciation in the next year? What is the risk of US dollar overshoot?
US Dollar Index
Fed overestimates the long-term rate
The message from the Fed has been clear in the recent notes. Most Fed comments have been consistent with a hike by the year end, which contributed to the recent hike of US dollar. But the most important is that Fed sees the long term rate around 2.75% or 3%. In such low growth potential environment, Fed may continue to low the long term rate one by one. As a result, US dollar will be in hurt in this situation.
US dollar relative value is not cheap
Currency is a relative term, and it is mistake to focus only on itself. European and Japan central bank provide the early sign to modify monetary policy, which give pressure to US dollar. The market still believe Draghi, European central bank president, will extent the QE program in the next few months, given his comment of no inflation signal. But there is the risk that European central bank taper to 60 billion per month in the QE program.
Japan has already changed its monetary framework, from the purchase amount to targeting yield curve. That means the bank of Japan will more focus on growth instead of inflation. Moreover, the cost-benefit balance of negative interest rate policy is unknown and it should make the hurdle for a further reduction in the policy rate very high. Overall, the external effect to push US dollar appreciation was past.
Compared to EM currencies, US dollar is also not cheap. US dollar's appreciation has been especially marked against the EM currencies in the past few years. With the commodity price rebound, EM currencies can be recovered. Furthermore, the stable China growth also makes a positive contribution on EM currencies.
What if US dollar goes over the range?
In conclusion, US dollar index should be in the range between 90 and 105, which is benefit to the risky asset. Policy risk may drive US dollar temporary higher. In that case, it is not good news for EM assets and US corporate earnings.