The US dollar, the world’s most sought-after safe haven currency, had an indifferent 2017. After enjoying a strong rally for four consecutive years, the dollar index was heavily beaten down in 2017; down 10 per cent last year.
Though the index began on a strong note last year, it failed to sustain the momentum and extend the rally. It made a high of 113.85 in early January and fell through the rest of the year, tumbling to a low of 91 by September. It recovered slightly from there to close the year at around 92.
What made the greenback halt its four-year rally?
Dollar index
The US dollar index indicates the value of the dollar relative to a basket of six other currencies — euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. Each of these has its own weight in the index. The euro (57.6 per cent weightage), yen (13.6 per cent) and pound (11.9 per cent) weigh the most, accounting for over 83 per cent in the index. Sharp movements in these, especially the euro, affect the dollar index more than the other currencies with lower weight, such as the Canadian dollar (9.1 per cent weightage), Swedish krona (4.2 per cent) and Swiss franc (3.6 per cent).
In 2017, the rally in the euro and the pound of 14 per cent and 10 per cent respectively against the dollar sharply dragged the index lower.
Domestic factors
Last year began on a positive note for the dollar as the Federal Reserve had just begun increasing interest rates in 2016. The Fed was all set for more hikes in 2017. The surprise victory of Donald Trump in the US Presidential elections in 2016 was another factor that boosted the dollar in 2017.
But soon, the tables turned. Trump’s tax policy changes hitting a speed-bump and the delay in the planned infrastructure in the US came as a big blow. Additionally, the Fed, which did not want to surprise the market any more, made sure to intimate the market about policy tightening measures well in advance. So, Fed meetings did little to boost the dollar.
Policy shift
The final blow was delivered by the Bank of England (BoE) and the European Central Bank (ECB), the two other major central banks. The shift in their policy stance triggered a sharp sell-off in the dollar and boosted their domestic currency — the pound and euro.
The ECB unveiled its plan to cut its bond buying programme last year. The BoE, on the other hand, joined the US Fed in hiking its interest rate for the first time in over a decade. These two major moves shifted the focus of the market from the dollar towards the euro and pound. As a result, the latter two gained strength.
The euro, which began the year around 1.05, surged 14 per cent to close 2017 at 1.20. Similarly, the pound rallied 10 per cent from 1.23 to 1.35 against the dollar.
The gainers
The dollar has great influence on the other asset classes such as commodities and equities, among others. Commodity prices, in particular, are hugely impacted by the movement of the dollar. This is because most major commodities are priced in dollars and its movement has an inverse correlation with commodity prices.
That is, when the dollar appreciates, commodity prices fall because a strong dollar will make it costlier for the purchaser (due to the exchange rate conversion), thus reducing demand. Similarly, when the dollar depreciates, commodity prices become more attractive for buyers; the increased buying then pushes up demand, boosting prices.
In 2017, a sharp 10 per cent fall in the dollar index helped the commodity prices rally through the year. Prices of base metals such as aluminium, copper and zinc were up between 29 per cent and 34 per cent. Crude oil was also supported by the weak dollar and prices gained over 12 per cent.
It is important to note that each commodity had its own fundamental reasons that helped its price rally and the dollar was just one of the supporting factors that drove prices higher.
Emerging currencies
Almost all the major emerging market currencies strengthened against the US dollar in 2017. The Russian ruble, Chinese yuan, Singaporean dollar, South African rand and South Korean won were up between 7 and 13 per cent against the US dollar.
A special mention is needed for the Indian rupee among emerging currencies. The rupee, which was on a continuous fall for six years, snapped the downtrend in 2017. The dollar’s weakness helped the rupee reverse and get higher, closing the calendar year on a positive note for the first time since 2010.
The rupee, which was hovering around 68 per dollar at the beginning of the year and threatening to fall to fresh lows, reversed direction and closed the year at 63.49, up 6.3 per cent.