By Mike Dolan
LONDON Feb 1 For all the frenetic activity in 2013 so far and in the face of a seemingly endless flood of newly-minted greenbacks, some of the world's biggest investors are already bracing for a rare U.S. dollar renaissance.
It may emerge by the end of the year.
To look at the 15 percent rise of the dollar against Japan's yen over in just three months, it's tempting to say the revival is already underway.
But the truth is that reflects Japan's success in weakening the yen. The more passive role played by the dollar can be seen by the latter's simultaneous 5 percent slide against euro.
The dollar's trade-weighted index against the major world currencies has done very little by contrast, hovering roughly where it was this time last year and in the middle of the 10 percent range it has traversed for some four years now.
What asset managers talk about, however, is a sustained multi-year rebound in the world's dominant reserve currency - one rooted in growing U.S. energy independence from the shale gas revolution, improving U.S. trade deficits as a result and economic outperformance that enables the Federal Reserve to wind down its currency printing presses before everyone else.
To put this in context, the last comparable move in the dollar's index was a 40 percent drop from the peak of the dot.com bubble in early 2000s to the depths of 2008 credit crash and Lehman bust in 2008. Despite brief stress-related jumps after that, it's not done much since.
The last big dollar bull market, however, was in the second half of the 1990s. A combination of higher U.S. returns following 1994's Treasury yield spike and a structural economic narrative surrounding the Silicon Valley boom combined to draw in foreign investors and keep domestic ones at home.
It's the potential re-run of that period that many investors are keeping an eye on - not for the coming months necessarily, but more likely over the next couple of years.
"We expect to see a significant re-rating of the dollar in the second half of this year," said John Stopford, co-head of fixed income and currency at Investec Asset Management, which steers more than $100 billion of assets around the world.
"When the dollar gets motoring, it tends to do so in long, multi-year sweeps of 10 years down, five years up. There are many structural features building behind this - energy and trade account improvements and a superior growth outlook - but the catalyst will likely be Fed policy."
As Investec and others point out, some slowing of the Fed's bond-buying and quantitative easing is a necessary trigger for a rise of long-term U.S. interest rates, but there's little sign of that happening for many months. The central bank's effective jobless target will now require as much as a 1.4 percentage point drop from the 7.9 percent unemployment rate recorded in January.
But Fed policymakers are already mulling the potential risks of its asset purchases on financial markets and so the debate on a wind-down of quantitative easing will likely emerge well before they actually move and be presumably discounted into market prices accordingly.
And assuming the economic outperformance over Europe and Japan at least persists, then the sequencing of central bank policy 'normalisation' would still leave the Fed ahead of the pack - even if the European Central Bank's untimely balance sheet shrinkage right now has strengthened the euro in defiance of recession.
Ewen Cameron Watt, chief strategist at Blackrock Investment Institute, the research hub of the world's biggest asset manager, said exact timing was always impossible to predict but a major dollar bull market over the next 5 years was likely.
"I can be persuaded with a great deal of certainty that over the next five years this trend is going to develop even though it's not going to be a development over the next few months."
Cameron Watt said the best way to look at it overall is simply the supply of dollars to the world, either through the Fed printing or via the trade and current account deficits which effectively push dollars abroad.
The shale and energy story is a secular one but cutting U.S. energy deficits will reduce the amount of dollars outside the country just when the Fed's money creation could well be slowing down too.
What's more, the effects of cheaper domestic energy before the rest of the world emulates the technological development is having other profound investment effects - such as foreign companies investing in plants within the United States to either take part in the drilling or lower their input costs.
French steel tube maker Vallourec, for example, has invested $650 million in a new plant in Youngstown, Ohio, to take advantage of the shale gas boom.
As to the fallout from a dollar bull run, a reduction in the supply of the world's main reserve currency overseas would likely tighten financial conditions elsewhere, especially for countries with current account deficits competing for global investment. And that in itself could reinforce the currency move for a period.
Although many emerging economies have developed more stable sources of domestic investment in the interim, it's no coincidence that the last period of prolonged dollar strength in the late 1990s came alongside a series of emerging market crises from Mexico to east Asia to Russia and Brazil.
The fresh burst of volatility on foreign exchanges this year after a long period of relative calm has certainly forced asset managers to rethink the currency markets and their implications - with a plummeting yen, a surging euro, a retreating Swiss franc and sinking sterling all adding to the mix.
The over-arching theme has been the unwinding of "safe-haven" trades as the global crisis eases but local narratives has driven all the moves - renewed Japanese yen printing; the return to battered euro zone assets and ECB tightening; or Britain flirting with triple-dip recession and European Union exit.
"What is remarkable is that for the last three months or so there really hasn't been a 'dollar story'," said hedge fund manager Stephen Jen. "The dollar has gone up against some currencies and down against others. However, I favour the view that, after the rounds of QE to artificially depress its value, the U.S. dollar will likely rise rather than fall."