Implications for the dollar

We make a modest but important claim: Since at least the late 70s the dollar has moved in a cycle against the deutsche mark and then the euro relative to the differential of shortterm interest rates.

These finding have a few limitations. First, the analysis says little about time — i.e., the duration of any phase or cycle. Second, this analysis has nothing to say about the magnitude of dollar moves in any phase or cycle.

At this stage, our efforts have been focused more on the direction of the dollar and interest-rate differentials. We also recognize that as other people look at the data, they may date the phases differently. Nevertheless, this approach offers a different way to consider unraveling the knot that connects currency values to interest rates.

The analysis does suggest the U.S. dollar is likely to continue to be well supported and probably has not recorded its cyclical high. For speculators, this implies buying the dollar on pullbacks. For businesses with euro receivables, it means high euro-hedge ratios are still prudent. For investors, it means currency risk on Eurozone exposures may undermine a portfolio’s performance unless the euro exposure is neutralized.

Because several currencies, including the Swiss franc, Danish krone, and several northern- and central-European currencies, shadow the euro either formally or informally, this analysis may be applicable to those exposures as well. Finally, the firm dollar environment the analysis implies should also provide a favorable backdrop for emerging markets in general.