Currencies are always notoriously difficult to predict and many investors do not even attempt to try and do it. Often the best stance one can take with currency is to look for periods of extreme over or under valuation as a point of attractive entry or exit. The past few months have seen the US Dollar enter a period of weakness after what has been a fairly prolonged period of strength.
The Dollar had been in a bull market since about 2011; however this was off a rather depressed base in historical terms. The question for most investors is where to for the Dollar from here. This is an impossible question to answer but we will try and elaborate on a few observations.
The best place to start as always is with valuation. From the graph below we can see that the trade-weighted Dollar (DXY) has come from a point of under valuation in 2011 to a point of overvaluation earlier this year based on Purchasing Power Parity (blue line). This theory is often put forward as the best way to identify a currency’s fair value. Then we can see that the blue line turns over and moves closer towards fair value – we can see that despite the recent pullback the Dollar still remains slightly elevated from a Purchasing Power perspective.

Figure 1. USD corrections
Source. Thomson Reuters, Credit Suisse research
One could argue there are now a number of factors that point to some further Dollar weakness in the near-term. Firstly, speculators are now only neutrally positioned on the Dollar – they have simply stopped taking long or bullish positions, but are not yet in any way bearish. Hence, there could be more scope for sentiment deterioration.
Another factor that is less positive for the US is that inflation continues to be lacklustre compared to expectations. Many have also questioned whether the Fed will raise rates again at all this year. Next, it is also apparent that the US is facing more political challenges than many people initially thought when Donald Trump became president. These challenges point to slower US GDP growth.
Having discussed all these points we also need to consider the counter argument. The US has much higher long bond yields than most other Developed Market economies. It has a healthier consumer and a Central Bank that is already into a hiking cycle. The labour market is also at all time low levels of unemployment. These factors all argue to the fact that the US deserves or warrants a currency that is slightly elevated in relation to supposed fair value.
At the end of the day we would argue that currencies around the globe are more balanced now than earlier in the year. Our main concern or thought process is how that translates to equity markets and the shares we buy. The largest move in currencies has been the appreciation of the Euro to the Dollar. The most obvious benefit is for the Euro area companies that have Euro costs and Euro based revenue. Hence, a stronger euro will hurt companies with large international exposure to revenue but Euro currency manufacturing or cost bases.
The stronger Euro should also have a benefit to the European consumer in the form of both lower inflation and continued accommodative monetary policy. However the counter of this is that European goods will now be less attractive from an export point of view and this will weigh on the real economy. We would argue this should keep further strength at bay. Therefore when we consider currencies and their effect on the world economies, they seem less skewed to a strong Dollar and more balanced. In terms of direction from here this is a far more difficult question.