Risks of Following the Crowd on Dollar and Yuan

If there is consensus on any single trade these uncertain days, it is that the dollar will continue rising, up 23 per cent since June, albeit with some volatility. Equally, there is agreement that an ascendant dollar will only aggravate the negative circumstances of emerging markets.

“2015 may turn out to be the year of localised emerging market currency crises,” notes Stephen Jen of SLJ Macro in London.

Less alarmingly, JPMorgan economists recently noted: “Many emerging markets are hobbled by some combination of depressed corporate profitability, excessive private sector leverage, tight financial conditions and poor governance,” to which add fears of capital outflows.

There is a lot of history on the side of the pessimists. Many emerging market corporates set aside the lessons of history and borrowed cheap dollars a few years ago, even if they lacked dollar revenues. They assumed that a rise was improbable — given that one of the points of quantitative easing in the US was precisely to weaken the dollar.

But now that the US appears to be moving (however reluctantly) to raise rates, while the Bank of Japan and the European Central Bank continue on the path of aggressive monetary easing, the euro and yen have dropped against the greenback, as have the currencies of virtually every emerging market.

The notable exception to the general pattern of course is the Chinese renminbi, or yuan, (which is also an exception to Mr Jen’s generalisation that now is the time to sell four letter currencies). Today, many market players assume the dollar will strengthen further, the euro and yen will continue to weaken and the Chinese will inevitably devalue their currency.

But neither the dollar nor the renminbi may fulfil those widespread expectations. Among those who think the dollar is at its cyclical peak is David Bloom, the chief currency strategist of HSBC, who notes that the dollar is already up 40 per cent since its 2011 low, a rise that way exceeds its average 20 per...