Wednesday, 03 October 2018 14:26

Higher US Rates, Stronger Dollar? Look Again

 

 

 

 

 

 

Eran Peleg, Chief Investment Officer

 

 

Higher US Rates, Stronger Dollar? Look Again

 

 

Currencies typically strengthen as interest rates go up. Higher rates/yields on offer draw more investors to the currency, pushing up its value.

 

The US Federal Reserve has been on a rate-hiking campaign since December 2015. 2-year US Treasury yields are now above 2.8%. At the same time, interest rates and bond yields in most other developed countries have remained very low, if not outright negative. For example, 2-year German government bonds are currently yielding (-0.5%). The yield differential is the widest it has been for decades.

 

 

US Dollar (Trade-Weighted) Index:

 

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The US dollar is up this year: it has strengthened by around 3% on a trade-weighted basis. However -- Surprise! -- when examining the dollar’s performance since the Fed started raising rates on December 16th, 2015, one discovers that over the entire period, the American currency has not strengthened at all. In fact, it is slightly down (by 2-3%) on a trade-weighted basis. The dollar did have a big up-move in recent years – however, it occurred in 2014 and in Q1 2015, before US rates started to rise. Since then, the dollar has generally been going sideways, within a wide range – see chart.

 

It is a puzzle why the dollar has not strengthened. There are several possible explanations for the phenomenon, including (1) the US interest rate move was priced into the currency well in advance, in 2014, (2) growth expectations for developed countries outside the US (e.g. Europe) increased more than for the US in recent years, and (3) the process of quantitative easing/tightening is confusing the situation. However, no explanation is satisfactory. For whatever reason, the typical relationship between interest rates and currency has broken down here.

 

Niels Bohr, the Danish Physicist, famously said: “Prediction is very difficult, especially if it’s about the future”. Sensible investors know that they can’t predict the future. What they can do is assess the risk/reward of any investment (or asset-class) based on a map of probable scenarios and their associated probabilities. Having said that, experienced investors know that currencies have always been notoriously difficult to deal with, more than equities and interest rates. It seems like it just got even more challenging.

 

 

 

 

 

 

Higher US Rates, Stronger Dollar? Look Again

Published in Insights
Wednesday, 08 August 2018 13:50

All is Fair in Love and War

 

 

 

 

 

 

  Eran Peleg, Chief Investment Officer 

 

All is Fair in Love and War

 

 

Since arriving in Office, US President Trump has adopted a confrontational approach to foreign policy. International cooperation -- that has increasingly dominated the world order since World War II -- has been thrown out of the window. As we have written before, this is a general cause for worry.

 

However, when it comes to current trade tensions with China, it is easy to understand why the US has been adapting its approach. China’s economic success over the past few decades has resulted in a significant change in the country’s economic position. Historically, China was a manufacturer of low value-added widgets and plastic toys – and US businesses and consumers benefited from the cheap imports. At the same time, the US was exporting to China higher value-added products. This all worked quite well until China moved up the value chain, and started to compete, head-to-head with the US, in the same products. For example, it was just announced that Huawei knocked Apple out of the 2nd place in worldwide smartphone sales.

 

So, the US has gone to war, a trade war. The US is imposing tariffs on Chinese goods, and the Chinese are fighting back. There is much to say about this trade war (and much IS being said…) – what are the risks and potential benefits, what are the respective players’ advantages and disadvantages, etc.  However, although it may not have been so to the US Administration from the start, one point is quickly becoming very apparent: a trade war is not just about tariffs. It is about competitiveness. And when it comes to competitiveness, China has more levers it can pull. China has more control over its economy. Its leaders can quickly decide on additional fiscal stimulus, while the US administration needs to get the approval of Congress. The Chinese authorities can easily take down interest rates, while in the US, monetary policy is managed by the Federal Reserve, an independent, professional body. And finally – China controls its currency’s exchange rate, while the US has relatively little control over the dollar.

 

 

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See what happened recently: how did the Chinese react to the 10% tariff the US announced it was going to impose on Chinese goods? They didn’t say much. They plainly depreciated the Chinese Yuan (against the US dollar) by nearly 10%, and thus largely negated the potential impact of the US tariff increase.

 

 

 

Published in Insights
Wednesday, 04 April 2018 15:31

Something Completely Different

 

 

 

 

 

 

  Eran Peleg, Chief Investment Officer 

 

 

Something Completely Different

 

 

 

You could have expected a completely different outcome.

 

Given the equity market sell-off, concerns about trade wars and rising US rates, you might have expected emerging market stocks to significantly underperform their developed market peers. Each of the above factors alone would typically be particularly negative for emerging market assets. Here we got them all together. Could not be a good thing.

 

And yet, emerging market equities have held up very well. Since January 26th, when the equity market rout began, until the end of the first quarter, emerging markets performed pretty much in line with developed markets – with both dropping around 7-8% (as measured by MSCI World and Emerging Markets indices, in US dollar terms). In fact, over the entire first quarter, since the start of the year, emerging market equities are up +1.4%, while developed markets have returned -1.3%.

 

Emerging economies are not as vulnerable as they used to be. One reflection of this is continued upgrades of the credit ratings of emerging countries over the past 15 years. Today, China’s credit rating (A+) is only two notches lower than the UK’s (AA), and Russia’s (BBB-) is only one notch lower than Italy’s (BBB). This helps but is not sufficient to drive financial asset prices in the short-term. What is more relevant in the short-term is economic momentum – and what we have seen is that since February, emerging markets (except for China, perhaps) have shown the sharpest pick-up in momentum, while developed economies have slowed.

 

Good signs of resilience in face of what could have been very challenging market conditions.

 

 

 

 

Published in Insights