A midsummer lesson from the IMF on the dirham, dollar and pound
The International Monetary Fund’s message on currencies has some clear implications for UAE residents and companies: transfer your money now and dust off your expansion plans
Trying to predict the direction that currencies will take is always a tough call and often a very fast way to lose money, as any forex trader will know.
But often you simply cannot avoid it anymore than you cannot avoid getting out of bed in the morning. Say, for example, you are an expat living in the UAE and want to buy a house back home.
It won’t just be a matter of deciding when house prices are right for your budget. You will also have to make a very large currency transfer, and that might make the strength of your home currency almost as important as house prices in your investment calculation.
So you can’t really duck out of thinking about currency valuations. It was therefore interesting to read the International Monetary Fund’s latest views on medium-term prospects for major currencies.
The IMF is, after all, the central bank of the world’s central banks. If anybody can predict how currency markets will move it is surely not a bad place to start, and for once its conclusions are fairly easy to understand.
In a nutshell, the IMF says the dollar, and that also means the dirham which is pegged at a fixed rate to the US currency, and the pound are all over-valued and heading for a fall.
The IMF puts the greenback as 10 to 20 per cent overvalued in relation to other major global currencies, based on near-term economic fundamentals and the blocked US political system.
And the British pound sterling was reckoned to still be around 15 per cent too high due to the economic and political uncertainty surrounding its negotiations to leave the European Union, and that despite its post Brexit referendum slump in value.
Conversely the euro was seen as 10-20 per cent too low given Germany’s persistently high current account surplus, and the catch up game that Eurozone interest rates will probably now play with the Federal Reserve’s more hawkish monetary policy.
Last summer in this column I was talking about a double-top for the US dollar at around US$1.05 to the euro so can’t say that I’ve been so surprised to see the slide in the world’s largest currency towards $1.20 this month.
Indeed, this does make me a little wary that the IMF’s latest prediction might be telling us what has already happened.
However, when you think that it was only a few years ago that the dollar was trading close to $1.40 to the euro, then clearly the swing in the pendulum does not look complete, although this could take months or a couple of years.
For the UAE that would mean a lower exchange rate for expats and tourists. That’s bad news if you want to transfer money home to buy a house or make some other investment in non-dollar or pound countries.
But it is good news for the UAE’s economy which has sailed close to recession in the past three years and now looks due for a currency boost from two directions: tourism revenues and oil revenues.
Visitors who have found the Emirates increasingly expensive in the past few years will come back, and the cost of living will fall for expats as food and other import prices drop.
And as oil is priced in dollars, a weaker dollar also drives oil prices up - an obvious bonus for one of the world’s largest oil exporting countries and the Gulf region in general.
The IMF report explained that the dollar strength of the past few years was driven by relatively strong US economic growth, interest rate hikes in contrast to monetary loosening in the Eurozone and Japan, and the expectation of a fiscal stimulus from the Trump administration.
As President Trump’s administration has gradually come to be recognised as the most dysfunctional since Jimmy Carter - with the Washington machine blocking the new president’s every action from his travel ban to healthcare reform - the dollar has taken a beating.
Now, partly as a consequence, US economic signals are looking very mixed and the prospect of further interest rate rises is receding, while across the Atlantic in Europe the business cycle is still picking up speed.
Only the UK economy with a political mess not very dissimilar to the Trump administration is faltering now. The British government lost its majority in parliament in this summer’s election and survives thanks to a pact with an extreme nationalist party.
Can it actually negotiate and conclude an exit from the European Union under such circumstances? What sort of a deal, if any, can it offer?
Nobody knows and such uncertainty is bad for business planning and fixed investment. The IMF’s reckoning is that the slump in the pound that began with the Brexit referendum last summer is not over.
That is probably a prudent view in the circumstances. Then again perhaps there will be another general election this autumn - as happened in similar minority government conditions in 1974 - and Brexit will be history.
Logically that ought to be magic for the pound sterling. On the other hand, if it meant the election of an extreme left socialist government of limited economic competence then it would be several more nails in the pound’s coffin.
But for UAE nationals and expats, the IMF’s message this summer on currencies has some clear implications.
Get on with overseas currency transfers just in case the IMF is right, and dust off local business expansion plans as the tailwind from a weaker dollar will be good for oil prices, trade and tourism.
As a final thought for investors, the falling US dollar, dirham and pound could give massively overvalued world stock markets a final leg up.
S&P 500 companies make half their earnings overseas, so a lower dollar means higher profits from abroad, while a lower pound is also automatically arbitraged into a higher FTSE as it also lists many global businesses.
Peter Cooper has been writing about finance in the Gulf for 21 years
Updated: August 6, 2017 01:20 PM