Last month I ended by saying that I expected the euro and the yen to continue to appreciate against the US dollar. Well, it was not long after that the greenback began a big rally against other major trading currencies. Rather than eat my words, I want to explain what this means and whether the dollar revival will last.
My key global investment theme has been that the credit crunch would cause credit to contract, causing global recession. But I recently added a coda that energy and other commodity prices (in which we were short) would collapse as a result, causing headline inflation to plummet towards the core rate in rich countries and restoring some modicum of purchasing power in the even harder-hit emerging markets.
This would restore some measure of freedom to central bankers. Markets would love that. Risk assets would have a big rally. And the dollar is also a risk asset.
The catalyst for the recent dollar rally was the European Central Bank’s shift in rhetoric at its last rate meeting to recognize that the eurozone economy is tanking.
| G4 central bank real policy rates |
| From 1999 to 2008 |
 |
| Source: Datastream |
The significance is that the ECB won’t raise policy rates any more.