Why stay in the USD in the current market?

The USD will strengthen even though it is currently at its highest point in years. Currencies are all about comparative advantage.

These are 4 comparables that make the USD attractive.

1)   China instability leading to world instability

The Yuan devaluation starting on Aug 11 was not large. It was China’s way of playing with another form of monetary policy following poor export numbers the week before. However, this was followed by shock waves in the currency and stock markets indicating that the world no longer believes in China as the locomotive of global growth.

2) Reduced revenues for commodity dependent countries

For months commodities have been dropping like a falling knife reflecting falling global demand. The falling commodity prices will mean a drop in revenues from commodities for resource-exporting countries, which will in turn lead to further pain for economies.

3)   Euro zone issues

While the last Euro PMI number was positive, reiterating the strength in German manufacturing, the France manufacturing PMI fell from 49.6 to 48.6.

The Euro zone has plenty of complicated issues that include the Russia Ukraine conflict, thousands of migrants flooding in, the Greece economy issue and the ISIS problem in their backdoor causing anti-Islam sentiment.

4)   Japan stagnation

Japan has been in a deflationary cycle since the 1990s and has been unable to break out of it even with fiscal and monetary policies. The Abenomics has not shown signs of success.

While the markets have reflected some of the above instability, the severity of these issues is yet to be fully realised.

US economy vs Global economy

As you can see from above, the global slowdown is happening. The US economy is strengthening but it is not strong enough to drive the other global economies as an engine of growth. It is also not immune from the global economy as seen from the Q2 2015 US company earnings where most have reflected a China slowdown. However, it is showing more strength compared with other economies.

The 2008 economic crisis forced the US to go through a painful economic restructure to return to fundamentals. The current asset levels in the US are only currently going back to pre-crisis levels.

As a result, US asset valuations are closer to fundamentals compared with the assets of the other economies that have shot up due to easy monetary policies (a good example is the housing prices in the US compared with the rest of the world.) Hence, a global crisis is less likely to cause as much pain to it than the rest of the world.

A lot of people are looking to the US Fed to gauge USD strength with the opinion that the central back may not hike in Sep due to the current stock market.

However, the rate hike is no longer as relevant to USD weakness or strength if the panic of the stock market continues. In situations of panic, people will revert back to the currency of the last resort- cash or gold. In this case, cash will be the core currencies, which are usually JPY, EUR, GBP, USD and of which the USD is the strongest.

Even if the stock panic stops, the fundamentals still show that the US economy is currently the strongest economy and the currency will reflect that.

The stock market panic will only serve to quicken its pace.