As we noted in various recent reports, our dollar bullish narrative is not predicated on the exact timing of the first Fed hike, but on the medium-term divergence between central bank policies. Even though the dollar has been moving in a wide range over the last several months, this theme has worked well over the last few years, especially in 2014.
See the DXY dollar index, for example.
This divergence between monetary policy patterns goes well beyond G10, but currency moves have not responded in the same way. In fact, there seems to be little correlation between interest rates and currency moves, as the table below shows. Brazil, for example, was one of the most aggressive central banks over the last twelve months, but the BRL has been one of the worst performing currencies. On the other hand, India and Hungary have been well in the dovish camp for the last several quarters and their currencies have outperformed.
As we previously noted, the big picture going forward looks a bit more nuanced. On one side of the spectrum, Latin American central banks stand out as a unique cluster of hawkishness. Colombia both started tightening cycles with 25 bp hikes inSeptember, while Brazil hiked 50 bp in July and more tightening is still possible. Mexico is finding it harder and harder to justify the tightening it had signalled at the start of the year, but Chile is likely to start its tightening cycle soon (perhaps even today).
On the other side of spectrum, we still see risk of more easing in a host of countries. These include China, Sweden, Switzerland, Australia, New Zealand, and South Korea. Also, expectations for a BOE hike have been pushed back to mid-2016. Lastly, central banks in Eastern Europe are looking dovish/neutral.
The ECB and the BOJ have recently been relatively less dovish by pushing back against expectations of imminent easing. However, many observers still expect further easing from both. We note that no country that has gone down the road of QE has ever stopped after one round.
South Africa was the only other major EM central bank to tighten, hiking 25 bp in July. With persistent deflation risks, Eastern Europe remains in dovish/neutral mode. Hungary has also stopped after its last 15 bp cut back in July. Russia is likely to resume rate cuts after pausing with its last 50 bp cut in July.
Asia is also easing. China continued its easing cycle with a 25 bp cut in August. India delivered a larger than expected 50 bp cut in September, while Taiwan cut 12.5 bp at its quarterly meeting in September.