SINGAPORE (Sept 22): The US Federal Reserve announced on Sept 20 that it would start reducing the size of its US$4.5 trillion ($6.1 trillion) balance sheet next month. It also stuck with its forecast to raise the federal funds rate again this year, citing healthy growth.

Following the announcement, Bloomberg’s US dollar index gained 0.5%. And a few market watchers are now betting on a reversal of the slide in the US dollar this year.

In spite of steady economic growth and improving employment data, the market has been sceptical that the Fed would raise interest rates, given that inflation has remained below its 2% target.

Since July, the market’s expectation of a Fed rate hike by year-end has declined — and, with it, the value of the US dollar. It is down roughly 9% this year.

Why should US dollar movements matter to Asian investors?

For one thing, a sustained rebound would stifle a rally in Asian equities. Also, the US dollar’s fall this year has been partially responsible for driving strength in Asian currencies this year.

Short-term events, such as central bank action and geopolitical crisis, more often lead to currencies being pushed out of whack against their fundamentals — creating opportunities for far-sighted investors.

“It may be hard to believe, but it’s easier to forecast currency movements over the long term than the short term,” says Stuart Allsopp, head of country risk and financial markets strategy at BMI Research in Singapore.

Like goods and services, currencies respond to the forces of supply and demand, which in turn are the result of several factors. Among them: trade, interest rates and GDP growth.

Which currencies should form part of your portfolio over the next 10 years?

Find out this – and more – in our cover story, “The undercurrents that drive currencies”, on The Edge Singapore (Issue No. 798, week of Sept 25), available at newsstands now.

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