Although predicting major foreign exchange (FX) trends is never easy, the potential for a major dollar bull market suggests FX could influence investment planning in the coming months. In this light, we examined how various equity risk factors have performed in a strong dollar environment, and found that the momentum factor historically outperformed.
The dollar rally and backdrop
The US Dollar Index (DXY) has risen over 8% from its May low driven by relatively strong US economic growth and favorable interest rate advantage.1 Dollar strength is well discussed in the market and the long dollar trade could be getting crowded in the short term, but fundamental factors are supportive to a sustained dollar uptrend. The Federal Reserve is ending QE3, while the European Central Bank and Bank of Japan (BOJ) continue with aggressive monetary stimulus. In fact, the BOJ was willing to buy T-bills at a negative rate in September. At the same time, global Purchasing Managers Index (PMI) data highlights the outperformance of the US economy. Recent manufacturing PMI numbers showed the US at 57.5 compared to 52.8 for Japan and 50.3 for the eurozone.2
Investment implications