Dollar Bulls Learn the Meaning of Complacency
(Bloomberg Opinion) -- President Donald Trump has made betting on a stronger dollar perhaps the riskiest trade in global markets. The Bloomberg Dollar Spot Index was pushing toward its highest level since last July on Thursday until Trump told CNBC in an interview that “our currency is going up, and I have to tell you it puts us at a disadvantage.” The dollar gauge promptly erased a gain of as much as 0.63 percent before ending the day a bit higher. By talking down the dollar, Trump is playing a dangerous game.
In Trump’s view, one of the keys to winning a trade war is through a weak currency, which helps make exports more attractive. But the greenback isn’t cooperating, with the Bloomberg Dollar Spot Index up about 6 percent since mid-April. To be sure, Trump’s remarks shouldn’t be surprising. In April 2017, Trump told the Wall Street Journal that “I think our dollar is getting too strong, and partially that’s my fault because people have confidence in me.” Then in January, Treasury Secretary Steven Mnuchin said a weaker dollar was good for U.S. trade. In April, Trump wrote on Twitter that “Russia and China are playing the Currency Devaluation game as the U.S. keeps raising interest rates. Not acceptable!” One big reason for the dollar’s strength has been the Federal Reserve’s decision to boost rates, which has drawn foreign capital to dollar-denominated assets. Here, too, Trump told CNBC that he was “not thrilled” by the Fed’s decision to increase rates.
In some ways, Trump is right. So far this earnings season, companies have pointed to a stronger dollar as the main headwind to earnings, not tariffs, according to Bianco Research. But that’s small potatoes compared with what could happen if foreign investors believe the U.S. was abandoning its long-standing strong dollar policy. Those investors, who own about half of all U.S. government debt outstanding and help finance the budget deficit, would be less inclined to own dollar-denominated assets if they felt the U.S. was pressuring the greenback lower. That could cause borrowing costs for the government, companies and consumers to skyrocket. The Trump administration’s desire for a weaker dollar could “become self-fulfilling if that is the White House’s objective,” ING strategist Viraj Patel warned in an email to Bloomberg News.
BONDS' BIG PICTURE
Treasuries hit their highs of the day after Trump’s comments, pushing yields lower, as bond traders focused their attention on his criticism of the Fed and the outside chance it causes policy makers to slow the pace of rate hikes. Perhaps they wouldn’t be so sanguine if the comments succeed in weakening the dollar. The thing is, the government needs foreign investors perhaps more than ever to buy up the bonds it needs to sell to finance a growing budget deficit as a result of tax reform. Wells Fargo & Co.’s economists and strategists put out a joint report on Thursday saying that based on their estimates of the deficit, the U.S. Treasury will need to raise about $1.1 trillion in cash from the public now through the end of March. But there are signs that foreign investors are balking. Treasury data show that foreign investors boosted their holdings of U.S. government from about $2 trillion in 2006 to about $6.2 trillion at the end of 2014. But that amount hasn’t changed since then. Also, International Monetary Fund data show that the dollar’s share of foreign reserves dropped to 62.5 percent at the end of March, down from a recent high of 66 percent in 2015 and the smallest percentage since early 2014. The ICE BofAML indexes show that U.S. Treasuries yield 2.20 percentage points on average more than the rest of the global government bond market, up from about 1.10 percentage points when Trump was elected in November 2016.
STOCKS HAVE BAD BREADTH
U.S. stocks were broadly lower Thursday in sympathy with global equities amid concern about China’s economy and currency, but that didn’t stop the bulls from feeling pretty good about the S&P 500 Index trading at its highest levels since the start of February and holding above the psychologically key 2,800 level. They have a lot to crow about, with corporate earnings for the second quarter forecast to have risen about 20 percent from a year earlier — despite the stronger dollar — and the government expected to say next week that the economy expanded at a robust 4 percent rate in the April-June period. Perhaps they wouldn't be so emboldened if they peeled back the market’s covers. If they did, they would see that this rally very narrow. As Gluskin Sheff & Associates Inc. chief economist and strategist David Rosenberg noted on Twitter on Thursday, when the S&P 500 first pierced 2,800 in January, the share of the index that had already reached new highs exceeded 20 percent. Now, that share is barely 5 percent. “When your breadth is bad, it’s time to freshen up,” Rosenberg wrote, adding that this is a “hallmark of a topping market.” Rosenberg is well known for his bearish leanings, predicting a recession in 12 months, but broader market measures are sending similar signals. The number of U.S. shares reaching a 52-week high has dropped to 176 this week from more than 600 back in January.
The commodities market formally entered a so-called correction on Thursday, with the Bloomberg Commodity Index dropping 10 percent from its almost three-year peak in May. The weakness has been widespread, with everything from oil to base metals such as copper to agriculture products slumping. For those who believe the market for raw materials is an early warning system for the global economy, the latest moves are distressing. Perhaps what’s more distressing is that those who deal in the commodities market are not optimistic about a rebound soon. Although trading patterns show that the Bloomberg Commodity Index has become “oversold,” which implies that a rebound might be imminent, that may not be the case this time, according to Gary Christie, the head of North American research at Trading Central in Ottawa. The trouble is that the losses gathered steam as the index broke below the rising trend line on July 11, fueling the sell-off, according to Bloomberg News’s Luzi Ann Javier. As such, the gauge’s moving average convergence-divergence indicator, a measure of price momentum known as the MACD, has held below the so-called signal line that could spark a rebound. That suggests there is “no reversal sign as of yet” and that the bearish trend is gaining momentum, Christie told Bloomberg News.
CHINA’S YUAN INCITES CONCERN
One of the big reasons commodities have been weak is China, the world’s biggest consumer of raw materials. Concern that the country’s economy is quickly decelerating grew on Thursday after its currency slumped to a one-year low as the central bank showed little sign of intervening to slow the yuan’s descent. The People’s Bank of China weakened its fixing beyond 6.7 on Thursday for the first time since the currency began tumbling in June, according to Bloomberg News’s Tian Chen and Emma Dai. Signs of further monetary easing are also adding strains, with China Business News reporting policy makers have made efforts to encourage bank loans and investment in lower-rated corporate debt. The yuan has fallen more than 4 percent in the past month, the worst performance among 31 major currencies. The fixing “signals the PBOC is not defending any line in the sand for the exchange rate and is comfortable with gradual yuan depreciation,” Tommy Xie, an economist at Oversea-Chinese Banking Corp. in Singapore, told Bloomberg News. The signs of easing are “certainly not supportive to the yuan, and the currency may see another wave of selling pressures ahead.” China this month experienced one of its biggest corporate-debt defaults yet, with the downfall of a coal miner that had ridden the country’s wave of credit until policy makers started their deleveraging campaign.
When the Bank of Canada raised interest rates last week, it described an economy running close to capacity where higher oil prices, a weaker Canadian dollar and stronger-than-expected business investment is fully offsetting the negative effect of trade uncertainty. A couple of high-profile economic reports due out Friday will help determine whether that assessment was on the mark. First, the government is forecast to say that retail sales jumped 1 percent in May, rebounding from a 1.2 percent drop in April. Also, it is expected to say that the consumer price index rose 2.3 percent in June, compared with 2.2 percent in May. In his opening statement at a press conference after the rate decision, Bank of Canada Governor Stephen Poloz said he understood there is concern about an escalation of global trade tensions, but the governor said policy couldn’t be made “on the basis of hypothetical scenarios.”
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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