NEW YORK, July 14 (Reuters) – Cooling U.S. inflation is accelerating a decline in the dollar, and risk assets around the world will benefit.
The dollar is down nearly 13% against a basket of currencies from last year̵[ads1]7;s two-decade high and is at a 15-month low. The decline accelerated after the US reported softer than expected inflation data on Wednesday, supporting views that the Federal Reserve is nearing the end of its rate hike cycle.
Because the dollar is a pillar of the global financial system, a wide range of assets will benefit if it continues to fall.
Dollar weakness can be a boon for some U.S. companies, as a weaker currency makes exports more competitive abroad and makes it cheaper for multinationals to convert foreign profits back into dollars.
The U.S. technology sector, which includes some of the big growth companies that have led markets higher this year, generates just over 50% of its revenue overseas, an analysis of Russell 1000 companies by Bespoke Investment Group showed.
Commodities, which are priced in dollars, become less expensive for foreign buyers when the dollar falls. The S&P/Goldman Sachs Commodity Index (.SPGSCI) is up 4.6% this month, on pace for its best month since October.
Emerging markets also benefit, as a falling US currency makes dollar-denominated debt easier to service. The MSCI International Emerging Market Currency Index (.MIEM00000CUS) is up 2.4% this year.
“For markets, the weaker dollar and its underlying driver, weaker inflation, is a balm for everything, especially for non-US assets,” said Alvise Marino, currency strategist at Credit Suisse.
The dollar’s fall has come as U.S. Treasury yields have fallen in recent days, dulling the greenback’s allure and boosting a wide range of other currencies, from the Japanese yen to the Mexican peso.
“The sound you’re hearing is a breach of technical levels across the forex markets,” said Karl Schamotta, market strategist at Corpay. “The dollar is plunging towards pre-Fed levels and we are seeing risk-sensitive currencies melt on a global basis.”
A continued decline in the dollar could increase profits for currency strategies such as the dollar-backed carry trade, which involves selling dollars to buy a higher-yielding currency, allowing the investor to pocket the difference.
The dollar’s fall has already made the strategy profitable this year: An investor selling dollars and buying the Colombian peso would have collected 25% so far this year, while the Polish zloty has returned 13%, Corpay data showed.
Paresh Upadhyaya, director of fixed income and currency strategy at Amundi US, is bearish on the dollar while betting on gains in the Kazakhstan tenge, Uruguayan peso and Indian rupee.
“When you look at what’s happening right now, the outlook for the dollar remains pretty bleak,” said Upadhyaya, who expects carry trades to thrive if the dollar continues to fall.
In the world of monetary policy, the dollar decline can be a relief for some countries, as it removes the need for them to prop up their falling currencies.
Among them is Japan. The dollar has fallen 3% against the yen this week and is set for its biggest weekly drop against the Japanese currency since January. Yen weakness has been problematic for Japan’s import-dependent economy and raised expectations Japan would again intervene in markets to support its currency after doing so for the first time since 1998 last year.
Traders have also been wary of possible action from Sweden’s central bank given the weakness of the Swedish krona. But this week the dollar is down almost 6% against the krone and is on course for its biggest weekly drop since November.
Continued strength in the yen could prompt investors to unwind the large bearish positions that have built up against the currency in recent months, pushing it higher, Societe Generale currency strategist Kenneth Broux said.
Of course, being dollar bearish has its own risks. One is a potential rebound in US inflation, which could increase bets on more Fed hawkishness and unwind many of the trades against the dollar that have thrived this year.
Although inflation has cooled, the US economy has remained robust compared to other countries, and few believe the Fed will cut interest rates anytime soon, potentially limiting the dollar’s downside in the near term.
Helen Given, currency trader at Monex USA, still believes the Fed will end the rate hike cycle before most other central banks, destroying the dollar’s long-term momentum.
While the dollar may pare some of the recent losses, “six months out it’s likely that the dollar will be even weaker than it is today,” she said.
Reporting by Saqib Iqbal Ahmed; Additional reporting by Dhara Ranasinghe and Ira Iosebashvili; Author of Ira Iosebashvili; Editing by Leslie Adler
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