Connecting the dots in global markets.
If a currency is to a nation what a share price is to a company, then the dollar just got slapped with a « sell » recommendation — and by none other than U. S. Treasury Secretary Steven Mnuchin. The Bloomberg Dollar Spot Index fell the most since March to its lowest since 2014 after the Trump administration official said in Davos, Switzerland, that a weaker dollar is good for U. S. trade. Although Commerce Secretary Wilbur Ross later indicated that markets overreacted and that the comments don’t mark a shift in America’s long-standing strong-dollar policy, investors are starting to worry about the fallout from a greenback that shows few signs of bottoming. After all, if a stronger economy, a booming stock market and three interest rate increases by the Federal Reserve weren’t enough to prevent the dollar from depreciating in 2017, what’s on the horizon that could turn it around? Although a weaker dollar could theoretically be good for exporters, there are also downsides, such as the potential for faster inflation and higher interest rates if foreign investors see less incentive to finance America’s growing budget deficit when the trade-off is holding assets in a depreciating currency.
The latest IMF data show that dollars make up 63.5 percent of global currency reserves, down from 65.3 percent at the end of 2016 and the smallest percentage since mid-2014. « Central banks and governments have been recently diversifying their reserve currency, which means selling U. S. dollars, » James Hughes, the chief market analyst at AxiTrader, wrote in a research note. COMMODITIES LIKE A WEAK DOLLAR In the commodities market, the reaction to the falling dollar was swift. At one point, the Bloomberg Commodity Index rose the most since August, touching its highest level since October 2015. Commodities are largely priced and traded in dollars, so a weaker greenback tends to translate into higher prices. And higher prices for commodities can mean faster inflation. Assuming the current levels of oil and the dollar are maintained, inflation as measured in import prices will likely jump to a 7 percent rate over the next few months from about 3 percent currently, Tom Porcelli, the chief U. S. economist at RBC Capital Markets, wrote in a research note. The biggest gainers on Wednesday included metals such as gold, silver and palladium, as well as copper. Even grains, which lagged behind the rally in commodities last year, saw some big jumps, led by a 5.25 percent increase in corn and a 11.5 percent surge in wheat. Soybeans gained 6 percent.
IT’S A BEAR MARKET IN BONDS The prospect of faster inflation brought on by a weaker dollar jolted the bond market as prices fell and yields jumped. No less than Ray Dalio, the billionaire founder of hedge fund Bridgewater Associates, said in a Bloomberg TV interview that bonds are in a bear market. That’s probably true. Average yields on all maturities of U. S. Treasuries as measured by the Bloomberg Barclays U. S. Treasury Index have risen from a low of 1.04 percent in mid-2014 to 2.41 percent this week. The benchmark has delivered a loss of 3.61 percent in that period. Commodity Futures Trading Commission data show hedge funds and other large speculators have been amassing bets against 10-year Treasuries to the most since early 2017. All it would take is for yields to rise an additional 1 percentage point to produce the largest bear market in bonds in almost 40 years, Dalio said. The timing isn’t good. Bond dealers expect the government to at least double the issuance of Treasuries this year to more than $1 trillion, according to Bloomberg News’ Liz Capo McCormick and Saleha Mohsin.
EMERGING MARKETS ROAR AHEAD Emerging markets are a direct beneficiary of the weaker dollar. The MSCI EM Index of stocks rose for the ninth straight day as an index of developing nation currencies surged the most since March. Commodities exports underpin the economies of many of these nations, and the higher prices for raw materials should give them a boost. For example, Colombia’s peso’s gained 1.51 percent on Wednesday and South Africa’s rand jumped 1.44 percent. To be sure, emerging-market assets were juiced by something unrelated to the dollar: a unanimous decision by a Brazilian appeals court to uphold a graft sentence against former leader Luiz Inacio Lula da Silva, likely preventing the front-runner in presidential opinion polls from seeking election this year. Brazilian stocks soared 3.72 percent while the nation’s currency appreciated 2.85 percent — the most in the world.
STOCKS TAKE A PAUSE Although Mnuchin pointed out the obvious when he said a weaker currency is good for trade, U. S. stock traders didn’t seem to embrace the notion, with the S&P 500 Index halting a three-day rally. Maybe traders are worried the Trump administration’s protectionist push will set off a trade war days after the U. S. slapped tariffs on solar panels and washing machines. Or maybe traders are concerned that foreign investors will find U. S. markets less appealing if the dollar continues to depreciate with the government’s blessing. The S&P 500’s gain of 24.5 percent over the past 12 months shrinks to 7.73 percent for euro-based investors assuming they aren’t hedged. “To the extent that trade is disrupted, it’s probably not good for economies, for U. S. companies and corporations, and would probably put pressure on the rising stock market, » Michael Cuggino, president of the Permanent Portfolio Family of Funds, told Bloomberg News.
TEA LEAVES All eyes will be on the European Central Bank on Thursday, when it will be wrapping up its first policy meeting of the year. Although no change in monetary policy is expected, investors will be closely watching what ECB President Mario Draghi says about the path forward in terms of bond purchases now that it appears the economy is strong enough to stand on its own. Bloomberg News’ Piotr Skolimowski reports that there’s one question Draghi won’t be able to ignore: Is the euro is too strong for the currency bloc’s health? In the six weeks since the last ECB meeting, the single currency has surged to the highest level against the dollar in more than three years.
