The bounce back by the US dollar could add a fresh complication for investors still reeling from the shake-out in markets earlier this year, according to AJ Bell’s Russ Mould.
With the greenback trading at its highest level since the beginning of the year, the investment director said the big question is whether the current valuation represents the next leg up in the dollar bull run that began in 2011.
If that is the case, the AJ Bell investment director (pictured) noted, it would be the third major advance in the currency since the ‘Nixon shock’ and American’s withdrawal from the gold standard and Bretton Woods in 1971. 
“This year’s bounce in the buck must be watched very closely by investors, as it has potentially huge implications for a range of asset classes and not all of them are positive,” said Mould.
“The dollar’s initial decline this year looked odd, given the US Federal Reserve’s gathering determination to try and normalise policy, by both raising interest rates and withdrawing quantitative easing (QE) under new chair Jay Powell.”
He added: “Sure enough, the greenback now seems to be responding to the monetary medicine.”
Indeed, as represented by the Bank of England’s US dollar effective exchange rates data – a comparison with a basket of other global currencies – the currency is trading at elevated levels.
However, a strong dollar can often cause challenges for investors for four reasons, as the below article shows.
Indeed, as the following chart shows, after a period of sustained dollar gains in 2000, global stocks fell before thriving on weakness between 2002 and 2007. It plunged again following a brief period of gains between 2007 and 2009.
US dollar vs S&P Global 1200 index
Source: AJ Bell
“All of this makes the broad stock market advances forged this decade appear like an interesting outlier, although a rising dollar didn’t immediately interfere with the bull market of the late 1990s,” Mould pointed out.
A strong dollar can also be particularly bad news for emerging market equities, as the next chart shows.
According to Mould, emerging markets often struggle when the dollar is strong. While recent weakness in the currencies such as the Russian rouble, Turkish Lira and Mexican peso might be explained by local political or economic developments, Mould said they could also be a “harbinger of a shift in risk appetite”.
US dollar vs MSCI emerging markets index
Source: AJ Bell
“Dollar strength preceded the 1982 Mexican debt crisis, 1994’s so-called ‘Tequila crisis,’ also in Mexico, the Asia and Russian debt and currency collapses of 1997-98 and also heralded a period of deep emerging market equity underperformance relative to developed arenas in the first half of this decade,” he explained.
Commodities, too, are sensitive to US dollar strength as the next chart shows. Indeed, like emerging markets, commodities have fared better during periods of dollar weakness and less well during periods of strong gains.
US dollar vs Bloomberg Commodities index
Source: AJ Bell
This follows a particularly challenging time for commodities in the recent past as prices languished as a period of low global growth.
There was one area where the asset class is more positively correlated to a strengthening dollar: global fixed income.
Mould said both global sovereign and corporate debt have performed well during times of dollar strength, although the relationship is not always a strong one.
He explained: “Although the relationships are by no means clear-cut, this makes sense. If investors accept the thesis that a strong dollar heralds – or is symptomatic – of a ‘risk-off’ period in markets, where dependable yields and capital safety are more likely to be highly prized.”
“In all cases, it is hard to divine which is the chicken and which the egg and correlation is guarantee of causation,” said Mould.
He noted that a strong greenback makes dollar-priced commodities more expensive for non-dollar-based buyers, compressing their ability to spend elsewhere.
Also, he said strong dollar makes it more expensive for non-dollar nations and companies to service any debts they have denominated in the US currency.
US dollar vs Barclays Investment Grade Sovereign Bond index
Source: AJ Bell
Mould added: “According to data from the Bank of International Settlements, emerging markets represent one-third of all non-bank borrowing outside the US that is priced in dollars, with liabilities of nearly $4trn.
“It won’t take a big fall in their own currencies against the American one to make servicing those debts much more expensive, to the potential detriment of government and corporate cash flow, and thus economic growth, since interest payments will take precedence over investment.”