- Dollar strength concerns markets
- Currency moves is doing the Fed’s work
- European demand for U.S. assets intensifies
- China needs further policy support
The global rate differential argument continues to have the USD racking up fresh multiyear highs against its peers. It’s the same capital market story, just a different day, and in some cases a different currency handle. Currently for investors, it’s difficult to look away. If you blink, you may miss another big handle move in the EUR, lost out on any year-to-date gains in U.S. equities, or be sideswiped by the flatness of varying yield curves.
The market is concerned that the combination of a stronger dollar and tepid global growth could provide unwarranted problems for the U.S. economy. Gross domestic product queries have U.S. equities seeing red. So far this week, both the Dow and S&P have managed to wipe out all their 2015 advances. Even commodity dealers are being swayed by the mighty buck’s direction and not fundamentals. Precious metal prices are sinking as investors continue to price in a near-term Federal Reserve rate hike.
U.S Treasurys Attracting Attention
For the fixed-income market, worries persist that a rampant dollar will do the Fed’s job. Is there a need for U.S. policymakers to be in a hurry to hike rates any time soon? U.S. yields are not rallying as would be expected in this environment. Why? Very simply, the European Central Bank’s (ECB) bond-buying program, launched on Monday, is making U.S. Treasurys look attractive. No one wants to invest in ‘negative’ yields. Much of short-term European debt has investors paying away the privilege to own product. Currently for portfolio managers, any return is a good return. The German 10-year bund has fallen below +0.20%, while German yields are negative all the way out to September 2022 issuance. Record lows are also being exhibited in Ireland, Spain, Italy, the Netherlands, Belgium, Austria and France. For U.S. policymakers, perhaps a strong dollar allows them to be “patient.” Fed Chair Janet Yellen and company will have the opportunity to enlighten capital markets on their position as early as next week. But will they? That is the million-dollar question.
Market Is Front-Running Draghi’s Program
This is not a busy week for capital markets on the fundamental front. In fact, it’s rather dull. Market volatility is being driven by the ECB’s quantitative easing (QE) program. It appears that the market is in desperate need to front-run ECB President Mario Draghi’s bond-buying program as the fear of collateral scarcity unfolds quickly. The speed at which longer-term European yields are being driven toward zero is helping to pick up the pace of the EUR’s decline.
Presently, the EUR is poised for its biggest quarterly decline. The shared currency has managed to weaken about -11.6% outright this year, slumping to another 12-year low this morning (€1.0600). With the EUR falling for a legitimate fundamental reason, and with the full support of the ECB, further heavy losses are likely to continue. The large divergence in the monetary stance of the Fed and the ECB will not be changing any time soon. Negative interest rates are forcing a wave of cash outs across the eurozone that are also weighing on the single currency. The size of the ECB’s QE program (about half the size of the U.S.’s and U.K.’s) was never going to “inflate” deflation alone. The ECB needs a much weaker EUR and it is getting it as eurozone domestic investors look abroad for higher returns and yields.
Chinese Data Reinforces Loose Policy
Investors have mostly been preoccupied with Europe. Soon they will have to begin focusing on China with a bit more urgency as data there continues to reveal that the world’s second-largest economy is slowing down.
In the overnight session, industrial production growth fell sharply to +6.8% in January and February, down from +7.9% in December, and well below market consensus (+7.7%). Retail sales growth slowed, too, to +10.7% from +11.9% in December. The softer reports suggest China’s economy is still losing steam and needs further policy support in the form of interest rate cuts and other monetary policy loosening.
The People’s Bank of China has singled out the rise of “real” interest rates on the back of cooling inflation as a further drag on the economy, especially as many companies struggle with heavy debt levels while customer demand remains weak. The last rate cut, a few weeks ago, did take the market by surprise, but they were not flatfooted. Nevertheless, investors should question if this is the beginning of a new rate-cut cycle. Present data would indicate there’s a strong possibility.