THE IMPACT OF A STRONG US DOLLAR

The USD (DXY Index) is one of the Prime market sentiment Indicators

If we think about it, there’s not a very meaningful yield attached to holding USD. This is predominantly prescribed to the stability and reserve currency status that the USD holds. In other words, to store funds in a safe manner and receive all of the associated benefits of holding the currency, you would not require a high yield in order to convince you to hold the USD as opposed to your local currency.

To elaborate, when the USD strengthens, this shows us that the market is for that period in time in a risk-off environment, where investors and market participants take some risk off the table, so to say.

What does a stronger USD mean over the long-term

When the USD increases we can see that riskier asset classes such as Commodities, Equities and Developing Nation Currencies tend to decrease. This represents the flow of funds across the globe in most instances.

To give an example of a long-term impact of an increase in the value of the USD, we can look at developing nations. Most debt across the globe has been issued in USD, meaning that the interest component is linked to a USD nominal amount. If the developing nations experience significant currency devaluation compared to the USD, their debt repayments become more and more expensive. When there are increased national debt costs faced by the affected nations, the consequences are at the cost of the well-being of their citizens. Taxes will have to increase, public spending will significantly have to be reduced, foreign investment will decrease.

The main problem and the true cost of the long term effects of the USD.

Most developing nations implement capital controls on the flow of their local currency. This means that there is a limitation on the amount of local currency its citizens and corporations may exchange for off-shore currencies. The reasoning behind capital controls has always been to accommodate the country’s monetary system and goals.

Citizens that live in these affected countries are helpless bystanders as there are mostly complicated and prolonged processes put in place by domestic regulatory bodies on requirements before being allowed to exchange their local currency for any foreign currency.
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Caveat Capital MGMT (Pty) Ltd is a CATII – Authorized Financial Services Provider (FSP no. 24777) registered at the South African Financial Services Conduct Authority (FSCA).