US dollar won’t automatically rise after Fed rate hike

by **Cals** Sun 29 Nov 2015, 18:48

Saturday, 28 November 2015

US dollar won’t automatically rise after Fed rate hike

by tee lin say

AMID the fears and speculation about the trend of markets from an upcoming impending Fed rate hike, many assume the US dollar will get even stronger, and as a result money will leave emerging markets.
Money is already leaving emerging markets because logically, money always flows to the highest yielding asset.
Also a strong dollar would not be good for the American economy because its exports will no longer be competitive.
History shows the dollar doesn’t automatically strengthen after a rate hike.
A lot of these fears come from the global monetary easing currently taking place, namely from the Bank of Japan and the European Central Bank. They are pursuing quantitative easing and worldwide, interest rates are at one of the lowest levels.

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US overnight rates, currently 0 to 0.25%, are also historically low but slightly higher than Europe and Japan. Thus, a tighter Fed policy would automatically strengthen the dollar and by right increase demand for the dollar.
TA Securities head of research Kaladher Govindan says the rate hike will cause a minor knee jerk reaction.
“The initial market reaction to the Fed chairman’s testimony on Nov 4, when she said a December rate hike was still on the table was a 50-point correction to 1,644 points in the benchmark FBM KLCI over six trading days. However, most of those losses have been regained since. So it could give back some of the gains upon a hike. The selling is expected to be minimal and not prolonged due to buying support from local funds ahead of year-end window dressing,” says Kaladher.
Certainly history shows that a straightforward relationship between a rate hike and a strong dollar does not exist.
Fisher Investments MarketMinder points out that while eight data points aren’t a huge array to draw big conclusions from, the data does not support the conclusion that a rate hike cycle means a stronger dollar ahead.
Four out of eight times, or exactly half the time, it strengthened ... that is in 1980, 1984, 1988 and 1999. In 1977, 1986, 1994 and 2004, the dollar weakened sharply after the Fed hiked rates.
In 1994, it weakened throughout the seven hikes in the tightening cycle that ran from February 1994 to July 1995. It then strengthened significantly over the next three years, when the Fed was overall cutting rates.
Fisher Investments says there are several contributing factors behind these inconclusive results.
“First of all, markets move in advance of widely discussed events, and a Fed rate hike has been one of the most widely discussed events in recent years. It isn’t sneaking up on anyone,”
“So while it is unknown to what degree, it is quite possible some of the dollar’s strength from over the past year is already tied to markets pre-pricing higher US rates,” says Fisher Investments.
It adds that lifting rates by 0.25% from its current 0 to 0.25% won’t really change the supply and demand factors all that much. The dollar is already modestly higher-yielding than most of Europe and Japan.
In fact, if the Fed would finally get on with the hike, it would likely remove a long-persistent false fear for investors,” it says.

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Kaladher says the major issues for next year would be the magnitude of monetary tightening in the US, crude oil price direction and China’s slowdown.
Tame inflationary pressure in the US and economic weakness in China and emerging markets could prevent US from tightening too fast.
“In fact, during the Asian financial crisis, the Fed tightened rates only once by 25 basis point in March 1997 and stayed pat until August 1998. Another point to note is that the FBM KLCI and ringgit did not react negatively to Fed’s rate hike between June 2004 and August 2007,” he says.
“When the peg was removed in June 2005, the Fed fund rate was at 3.25% and hit a high of 5.25% in August 2007 before the next loosening started the following month. Ringgit was at RM3.50 then,” says Kaladher.
Founder and chief strategist of Pheim Asset Management Sdn Bhd Dr Tan Chong Koay expects the US economy to perform better next year even if the Fed were to increase its rate in December 2015.
“I am not surprised if China’s economy slows down slightly in 2016. In the coming year, Europe’s performance as a whole should not be worse off when compared with 2015,” he says.
Tan adds that while Asian markets are not performing that well this year, there is a silver lining in this because of the opportunities it brings.
“I consider the weakness in currencies against the US dollar in some countries as not necessarily bad news. The general trend in declining share prices (for some) coupled with weakening currencies make the stock markets attractive. I expect the fund flows to at least selectively return to attractive emerging markets,” says Tan.
“Although Malaysia faces the problem of low commodity prices and some political issues, the key is to find undervalued companies that have low gearings, proven track records and growth potentials especially those that export to countries with stronger currencies.”
Tan says the longer term investors should be looking into accumulating undervalued and well-managed companies with growth potentials.
“Low oil and gas prices may continue to stay for a while. It is good for manufacturing companies whose costs of production rely heavily on oil and gas,” he says.