Non-financial, non-trading companies should only think about markets that have a strategic impact on their business. For instance, a company in specialty chemical exports should certainly be thinking about what could happen to oil prices, since all their raw materials are petroleum-based, and oil price movements affect their underlying business volumes. By the same token, this company should not waste time thinking about what will happen to dollar/rupee since, even though its top and bottom lines depend on how dollar/rupee moves (and their risk management process), the value of dollar/rupee is not strategically important to its business. Thinking about the rupee (or the dollar) is best left to professional FX traders—complete with full focus, disciplined stop loss and take profit—or to privileged people like me who have to write columns from time to time and have the luxury of pondering the market without risk of loss and with the caveat that it is all just so much gas. In this spirit, I was looking at a chart of the dollar index (DXY), which fell from a high of 103.3 at the start of 2017 to 91.1 in September, after which it bounced up a bit and has been hovering sideways since. The big question everyone is pondering is whether the dollar will turn around (which will be blamed on Trump) or whether it will continue weak and perhaps fall further (which, again, will be blamed on Trump).
The truth, as always, is that nobody knows, but the chart I was looking at shows that DXY has traced a double head and shoulders pattern (if there is any such thing), which was broken first when it last fell below 92.8, signaling that it would fall further with a target of 90.7. Significantly, it is almost at this level, but, importantly, has already breached the second part of the double H&S, which would have a target of 87.42! Now technical analysis—and, certainly, my technical analysis—is no final word. But it does provide a framework to think about the market. I note, for instance, that commodity prices, which are generally negatively correlated with the dollar, have been rising for some months. Copper and aluminium are both up around 50% over the past 18 months; oil, which has also risen around 40%, is poised to substantively break $ 70, after which it could be looking at a blue sky. Gold, too, is higher at around $ 1,350 and if this trend persists, it, too, is looking at a clear sky. All this could jibe with a weaker dollar, which would mean—oh my God—a yet stronger rupee.
Of course, at some point the trend will turn—it always does—and, as always, the seeds of the turning are in the very forces driving the trend. Rising commodity prices, by definition, stoke inflation, and recently, I heard a very interesting comment from a client who said he believes that China, after years of exporting deflation, has started—or will soon start—exporting inflation. And, as we all really know, but don’t want to think about, is that when inflation starts up, it usually moves really fast. And coming as it will after a long, long period where everyone was worried about deflation, it is likely that the controlling reaction will be too slow or too weak. Already, there are many analysts who are saying (hoping) that the Fed will not raise rates three times in 2018, as it has said it will.
What if it has to raise rates more sharply and/or more often? The US economy is certainly as close to full employment as it can get, and once the inflation pony turns into a horse, look out! This sort of surprise could certainly shoot the dollar higher, trash US equity markets and change the current risk-off behaviour in a hurry. Emerging markets—India amongst them—would see a bolus of outflows, certainly from the debt segment. EM currencies would correct as well; the rupee, which is particularly dependent on debt inflows, would tank, falling back to a sounder, more sustainable level. Now, whether this scenario—where the dollar weakens further and then suddenly reacts upwards—pans out and what the time horizon would be is anybody’s guess. Which is why, as I said at the start, while I am privileged to be able to think about all this, if you are running a business or the treasury in a business don’t waste your time reading all this what-could-be-nonsense. Stick to your risk management process and go home happy.