February 14, 2019
February has started out with a lot of noise in the markets. Equity markets around the world have continued a bull run after a disastrous few months to close 2018. Our favorite indicator — the U.S. dollar —seems to have been in the shadow compared to everything else that is going on.
The most widely watched, trade-weighted dollar index – DXY – has slowly risen each day this month and is back at levels we last saw towards the end of 2018. The story of the dollar reflects what we have been discussing in the whole global economy. While the dollar's drop in January followed market repricing of expectations of short-term interest rates in the U.S. (such as the seeming disappearance of rate hikes and hushed whispers of possible rate cuts), the rise in the dollar's value in February is also due to other major economies being revealed as weaker than previously expected.
Interestingly, the dollar has performed better against developed market currencies than emerging market currencies, reflecting the divergent performance in growth momentum. Developed market economies outside of the U.S. have come out with their own dovish tones as they face aging economies, immigrant issues and geopolitical uncertainties putting a halt on economic growth.
Conversely, emerging market forecasts have been relatively stable after being battered severely last year. Another reason why those currencies are performing better than the dollar is because of the higher interest rate levels that they offer. When the dollar is range-trading and does not move a lot, international investors who hold cash tend to pool their money in these higher yielding currencies, at least temporarily. While performance isn't stellar in those, standing still while the rest of the world moves backwards actually amounts to relative out-performance.
The entire global economy can be described as marking time until the major global economic event of year — the U.S. trade tensions with China — gets resolved. The numbers alone may not bear out, as international trade is still a minor part of the overall U.S. economy.
But the resolution — or escalation — of the trade war with China sets in motion a lot of dominoes that could reverse or exacerbate the dollar's current trend. A positive resolution would set a new paradigm for international trade that will be adopted in the developed world, likely resulting in more growth-potential globally. If all this comes crashing down or remains stagnant, there will be a realignment of the global supply chain system that will benefit some countries — emerging economies in particular —at the expense of others.
Our View: The economic news has been pretty tumultuous this year, with U.S. government shut downs, Brexit deadlines approaching with no concrete resolution and U.S.-China trade talks that we hear are still far apart from reform demands. And yet the dollar remains almost alarmingly quiet. The premise for this is that the U.S.-China trade war will resolve more toward the upside than the downside. The same can be said of market expectations about Brexit, for that matter. We are also in the camp of positive resolution too, anticipating that the dollar will not react much after these issues are resolved. At least, let's hope for that!
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