Dollar’s drag yet to be felt

Good morning. It’s Jenn Hughes here, filling in for Rob and Ethan. For those who love high-stakes drama and are already over New Hampshire, Tesla is reporting after the close. For the rest, there’s plenty of upcoming earnings likely to produce a more measured response. Email me your top picks: jennifer.hughes@ft.com.

But what about the dollar?

Think of the best-performing asset of 2024 so far, and chances are, the dollar isn’t first to mind. With stocks hitting records and bonds betting on rate cuts, the humble greenback hasn’t grabbed the headlines.

But it has risen 2.3 per cent since the end of December, beating US stocks (up 1.7 per cent) and bonds (down 1.2 per cent). This wasn’t supposed to happen with forecasts pointing to a weaker dollar this year as the Federal Reserve’s highly anticipated interest rate cuts make the dollar less appealing.

Predicting currencies may feel like betting on the “outcome of a coin toss”, as former Fed chair Alan Greenspan put it. But ignore the forex markets, or get them badly wrong, and the effects can be painful. Just ask anyone who bought Japan’s Topix index last year using unhedged dollars:

As the above chart shows, they’d have a third of their gains eaten up by the weakening yen. In dollars (pink line), Topix buyers’ investment gained 16 per cent, but 25 per cent (dark blue line) for yen-based investors. The gap is even more stark for iShares MSCI Japan ETFs. Plaudits to holders of the hedged fund (green line).

Closer to home, currencies matter too. A 10 per cent slide in the trade-weighted dollar (known as the DXY index) adds roughly 3 per cent to US corporate earnings, note Bank of America strategists. DXY managed a 5 per cent decline in December before its January rally.

So what gives now? Step back, and few are predicting a dethroning of “King Dollar”, as it was dubbed in 2022. The chart below shows why. It may be off highs, but it’s further away from anything considered weak:

The greenback’s continued general strength seems justified, too, when there are few signs of an end to US exceptionalism in market performance and depth, as Rob discussed last week. Nor have the alternatives changed much, in spite of the Brics’ best efforts.

There is still plenty of space for the dollar to edge lower this year, though, without losing any claim to a crown.

A hefty 71 analysts polled last month by Reuters predicted on average the dollar would ease about 3 per cent to $1.12 against the euro and about 8 per cent against the yen to ¥137. The two make up about 70 per cent of DXY, according to Bloomberg.

Back to this month’s rally. The key is most likely short-term rate differentials. The dollar was first among currencies to price in lower rates at home, after the Fed began publicly debating the potential for rate cuts. Discussions at central banks elsewhere were not so advanced. That pushed the dollar sharply lower but others are catching up.

“The dollar curve remains aggressively priced for rate cuts, while other developed market curves have room to catch down to the US,” said JPMorgan’s team at the end of last week. “How other developed market central banks respond to the onset of a Fed easing cycle is as important a part of the dollar puzzle as the Fed reaction function itself.”

This month officials from the Fed’s Christopher Waller to European Central Bank president Christine Lagarde have warned against expecting too much too soon in rate cuts. As a result, investors are starting to adjust their expectations for which central bank moves and when, buffeting currencies in the process, without changing the overall direction much.

BofA’s team managed to make this bumpy ride sound almost cheery: “We believe this is a year to sell dollar rallies, but we also expect that we will get such rallies, particularly in the first half,” they concluded.

Hold on to your hats. Or crowns.

Worse than China

Even a rally this week for Hong Kong stocks has left the benchmark off about a tenth this year.

Causes include disappointment in China’s struggling economy, investor wariness over its unpredictable policymaking, institutional investor disaffection given Washington’s tensions with Beijing, and selling related to derivatives.

Alas for Hong Kong, while China is responsible for the general gloom, mainland losses have been more limited, with the CSI 300 (pink line) off a mere 6 per cent:

Officials telling institutional investors not to sell is likely to be a key reason for that. More such buying might follow after Premier Li Qiang called this week for “more forceful” measures to boost the market and confidence.

The effects are likely to be felt less in Hong Kong, however. That’s partly a result of the city’s more global investor base, which has soured on China. But it’s also a legacy of China’s habit of carefully dividing its markets, producing gaps in valuation that have developed over years.

Thus you can buy a “H”, or Hong Kong, share in insurance company Ping An for HK$31 (US$4) or an “A” share in the mainland for Rmb39.4 (US$5.49) but with little hope the two, which are otherwise identical, will converge.

This week, an index tracking the premium paid for dual-listed stocks such as Ping An reached its widest since 2009. Hong Kong’s tickers haven’t traded at a premium since 2014, when China was deep in a post-bubble stock market trough.

Hong Kong’s biggest problem is that it lacks a strong story of its own to boost interest and investment beyond its ties to China.

On the plus side, the city has reinvented itself multiple times, from colonial backwater to manufacturing giant and more recently a financial centre. On the downside, its giant neighbour wasn’t so overwhelming in economic terms back then. Unless or until that new Hong Kong story emerges, its markets will continue to be punished for being near, but not quite, China.

One good read

It’s not exactly a vote-winning policy idea, but Americans need to pay more car insurance, The Economist argues.

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