| LONDON, July 5
LONDON, July 5 U.S. monetary policy is zigging
while the rest of the world is zagging, and the world should
brace for a protracted dollar surge, more strains for developing
economies and volatility in global markets.
After two weeks of signalling by central banks, investors
are betting the Federal Reserve will raise U.S. interest rates
within 14 months. No similar move is seen in the euro zone,
Britain or Japan before 2016 at the earliest - the first major
divergence in rate expectations for five years.
Prospects of less Fed money printing and the European
Central Bank's promise this week to keep interest rates low have
already pushed the gap between U.S. and German 10-year
government bond yields to its widest since 2006.
The developing policy gap, and the United States' stronger
economic outlook, means many investors are starting to assume
the dollar is in the foothills of a mountainous rally.
That could provide a fillip for struggling European and
Japanese exporters but would be bad news for emerging economies.
A stronger greenback has a depressive impact on
dollar-priced commodities, raises dollar borrowing costs for
companies and developing countries, and may ultimately stem the
flow of U.S. investment overseas.
Almost half the world's $80 trillion of private pension,
insurance and mutual fund savings originates in the United
States, and long-term shifts in the dollar's exchange rate can
profoundly change their calculation of overseas returns and
hence their preference for home or foreign markets.
"It's potentially going to have a big impact on the dollar
and U.S. fund managers who are the biggest investors in the
global economy," said UBS strategist Manik Narain.
"They have been orchestrating the big inflows into emerging
markets and now for the first time in 13 years they are seeing
real U.S. interest rates are on the rise."
The dollar has risen sharply against Japan's yen and
emerging market currencies all year, but the latest shift in
monetary outlooks within the developed world looks likely to
push it up against the euro, sterling and other G7 currencies.
"We're big proponents of a stronger dollar - it's the
central investment thesis of this period," said Scott Thiel,
head of global bonds at the world's biggest asset manager,
BlackRock - which has almost $4 trillion under management.
Others say the order in which countries were sucked into the
global crisis is the main issue. But dollar strength still
emerges under that scenario.
"There's potential for the appreciation of the dollar versus
the euro and also against Asian currencies," said Arnaud de
Servigny, chief investment officer at Deutsche Bank Wealth
Management. "The entry into the crisis was the U.S. first,
followed by Europe, followed by Asia. Now the first out is the
U.S., followed by Europe, and there's some uncertainty in Asia."
Prolonged periods of broad dollar strength have been few and
far between since exchange rates were allowed to float in 1973.
Seismic dollar swings in the 1980s also resulted from
mismatched economic cycles and monetary policies either side of
the Atlantic and were met with bouts of central bank
intervention, first to cap the dollar and then to stall its
Investors are looking at 1994 as a parallel for the present.
Surprise Fed rate rises that year pushed bond yields higher
everywhere, even as Germany's Bundesbank - then Europe's most
powerful central bank - was furiously easing policy.
The interest rate gap peaked in 1995, the trigger for six
years in which the dollar - still the world's main reserve
currency - appreciated more than 40 percent on the Fed's broad
While the dollar has been gaining strength, the Fed's broad
dollar index has risen only 4 percent so far this year.
The late 1990s saw major crises in emerging markets as
dollar strength tightened global financial conditions and
depressed world commodity prices, and as U.S. money returned
home to what was seen as a relatively safe high-growth story in
This week's historic decisions by the ECB and Bank of
England to offer "forward guidance" on interest rates stands in
contrast to the U.S. Federal Reserve's timetable for less money
printing and higher rates over the next two years.
With Japan also still in the midst of a renewed and
aggressive monetary easing, the Fed's relatively hawkish leaning
looks out of step with its major Group of Seven allies.
And despite attempts by Fed officials to emphasize
conditionality, a hefty 195,000 rise in U.S. non-farm payrolls
in June will only reinforce that view.
But could a dollar rise itself be enough to make the Fed row
Jim O'Neill, former chairman of Goldman Sachs Asset
Management and long-term proponent of emerging economies, told
Reuters on Friday that the exchange rate fallout may be critical
in shaping "reaction functions" around the world.
"The dollar is likely to rise but the Fed doesn't want to
preside over a major tightening in financial conditions and so a
huge dollar rise may itself contribute to the Fed toning down
what it said," said O'Neill.
Big developing countries like China could also help
themselves, by further reducing their dependence on the dollar
for trade and investment, he added.
"The notion that emerging economies are always vulnerable to
the curse of the dollar's exorbitant privilege is in their own
(emerging countries') hands."