Blotter: The end of the strong dollar fallacy
Never has so much been written that has meant so little. This could easily be the synopsis on the performance of financial markets over the course of the last six months. While those of you at the front line of investing will feel like financial assets have been volatile, especially in comparison to the stratospheric Sharpe ratios produced by risky assets in 2017, in the aggregate, this has not been the case. To summarize, global stocks, the USD and long duration US bonds are all stuck in a range. The three most important drivers of global investment returns are gyrating within a tight band and not reflecting the volatile narratives being expressed by pundits, the financial media and frankly most of you. The notion that financial markets are a window into economic and political reality has never been more flawed.
Now, I appreciate that it is much more nuanced than that. EM and investment grade credit are having a tough run and technology continues to go along its merry way, but the reality is that the average 60/40 equity / bond, benchmark hugging portfolio has done very little since the start of the year. Unfortunately, global economic headlines, dominated by the Trump administration are creating the belief that the world is a much unrulier place than financial assets would have us believe. The USD is a perfect example of this. The USD index, DXY, has been stuck in a relatively tight trading band, roughly 6%, since asset volatility normalized back in early February, yet the prevailing narrative is one of overwhelming USD strength. Forget President Trump’s tweet on Friday. The mindset amongst, especially macro oriented investors, has been one of perpetual USD strength when the facts are that the USD hasn’t really moved a lot, especially in the last few months. While investors in Turkey and India will feel like the USD has been all powerful, in the big picture, USD strength arguments have been greatly exaggerated.
While President Trump’s social media assessment of global currency markets imply that he may have gone to the Recep Tayyip Erdogan School of Economics, I get the sense that this week’s headlines and internal investor discussions alike will be centered around the end of the USD bull market that wasn’t. With the USDCNH rate at its highest level in several years and more importantly, growing evidence that the PBoC is orchestrating a trade weighted soften of the RMB, talk of competitive devaluations will become of growing narrative with investors and the Trump administration alike. While President Trump will focus on the unfairness of the global trading environment as his last political weapon as he heads towards likely defeat in the House of Representatives in November’s mid-term elections (see last week’s flagship report), his tweets cannot upend the prevailing reality. His jabs at the Federal Reserve won’t alter the path of rate increases. His tariff threats against China won’t stop them from employing fiscal and monetary means to ease the burden on the small Chinese companies affected. And while the Europeans are more prone than others to discuss auto tariffs, the bridges that President Trump has burnt in recent weeks may mean a tougher stance by Brussels. The USD may be President Trump’s latest shiny object to garner his attention, but the economic consequences appear limited to twitter induced daily gyrations.
So, the USD will remain stuck in the same, broad trading range it has exhibited in the past six months. That said, the more tactical amongst you must appreciate that his rhetoric will have consequences and that is that the USD is a tactical sale into strength for the balance of the summer. This has been a strategy we have promoted for months now but it will finally provide some rewards. The Euro, the Australia dollar, and GBP appear prone to tactically bounce. Hard to paint a scenario where EM equity doesn’t outperform for a period.
The key question for me over the next few months is whether US long duration yields can rise significantly while the USD is heading back to the bottom quartile of its three-year trading range. Despite, what is likely to be a week of strong US tech earnings and confirmation of strong Q2 GDP, I remain very skeptical. Tariff tensions are only going to rise in the next three months and this must cap yields and equity performance. MSCI World and US 10-year bonds will head back towards their late June lows throughout August.
You don’t want to be Steven Mnuchin this week, who will not get a warm reception at the G20 Finance Minister meeting in Argentina, but these events tend not to move markets. The ECB meets on Thursday, but will mostly be about the technicals regarding the ending of QE.
On Monday, Singapore prints CPI, and Germany prints manuf. PMI. On Tuesday, Japan, the EU, and the US print manuf. PMI. On Wednesday, Australia prints CPI, the EU publishes M3, and the US reports on Housing. On Thursday, South Korea prints GDP, and the US reports on Durable Goods Orders. On Friday, Japan prints CPI, and the US prints GDP.