Foreign exchange markets have started the year sedately, compared to the same period the last year. Last year, the US Dollar Index (DXY) appreciated by 4.5%. In the last week of 2016, it was apparent that markets were positioned for further US dollar’s strength.

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We have seen some early signs of consolidation. China put up restrictions on capital outflows by individuals, and allowed a sharp spike in Swiss short-term interest rates. In the medium run, the following trends are worth watching. First, the relatively strong fundamentals of the US. US equity and real estate markets are at all-time highs, and there will be a wealth effect. Unemployment is below long-term trend, and wages are beginning to rise. Household debt is down from 100% of GDP in 2008, to below 80% now. US corporates are sitting on record levels of cash. US remains the centre of global innovation and new technologies. All this doesn’t make for an economy that needs too much stimulus, before it increases its consumption and investment. Second, Europe continues to face existential questions around its political and economic institutions. China’s economy continues to be burdened by banking debt to the extent of 2.5 times its GDP. Third, is the threat of populism and inward looking polity all around the world.

The first trend of a fundamentally strong US trumps the other two. At close to 25% of global GDP, US can support global trade and growth, and can mask global economic vulnerabilities, leading to higher interest rates in the US, further US dollar strength, and capital  pullout from emerging markets.

A combination of the second and third trend dominates the first, triggering a global risk-off. which could impact emerging market economies. This might also see rise in DXY as a haven currency.

Both routes, therefore, seem to still imply dollar strength but there are risks. Further, growth in Europe may surprise on the upside, and squeezes out short euro positions. Lastly, if the US was to expand its fiscal deficit far too much, that might undermine confidence in the economy.

Given the potential for further DXY strength, the fact that the rupee is overvalued by 18% in Reer terms, and the overhang of unhedged currency exposures in India, India Inc would be well advised to buy insurance against rupee depreciation in 2017. The current phase of DXY positioning might present opportunities in this regard.

The writer is regional head of financial markets for Asean and South Asia of Standard Chartered