In a recent article with the title “Moving to the right side of the “Dollar smile”, SLJ’s managing director Stephen Jen writes about the several reasons why he believes the dollar will strengthen this year (according to his “smile” graphic), being one of them the deceleration of the emerging markets (EM) and Europe as the US economy improves… highlights below:

US Dollar

“… the risks to the U.S. economy are biased to the upside, while those to the European and Chinese/EM economies are arguably biased to the downside. In this scenario, a meaningfully large growth gap between the U.S. and its G7 trading partners should lead to outperformance of the dollar, which is still substantially undervalued, in our opinion… if the U.S. is to lead the world’s recovery from now on, which we suspect is the case, the U.S. can enjoy such a significant growth premium that more risk-taking could be accompanied by a strong dollar (point C), just as it was in 1999-2000 and 2005.

On China’s slowdown and its effects on currencies…

“China is slowing but will not crash. However, even a soft landing in China may have material effects on the rest of the world. We discussed the mechanisms through which China’s soft landing could affect the likes of Australia and Brazil – both of which have already begun to decelerate. We have two thoughts to add here. First, due to the extreme monetary policies implemented in most DM (developed markets), liquidity has leaked to EM and helped fuel their credit cycles, some of which may be maturing. China’s mature credit and housing cycles should be seen in this global context, that they are partly the results of extremely easy monetary policies in the U.S. and the de facto RMB peg. Similarly, Brazil is decelerating partly because its credit cycle may be maturing. Our point is that, while DM may be in a multi-year deleveraging process, EM has been in a multi-year leveraging process. We are witnessing signs that the EM’s credit cycles may be starting to turn, before the DM countries are able to re-leverage again. Australia could also be included in this discussion. Second, if we consider that the U.S. may continue to recover, while China will decelerate in 2012, AUD should underperform CAD, and BRL should underperform MXN.”

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