Articles tagged with: Treasuries

The Strong Dollar: Good or Bad?

What is dollar strength and who invests in it?

You may have heard that the dollar is “strong” right now. You may have also heard that a strong dollar amounts to a headwind against commodities and stocks.

While there is some truth to that, there is more to the story. A strong dollar does not necessarily rein in the bulls, and dollar strength can work for the economy and the markets.

The U.S. Dollar Index has soared lately. Across July 2014-February 2015, the USDX (which measures the value of the greenback against key foreign currencies) rose an eyebrow-raising 19.44%.1

On March 9, the European Central Bank initiated its quantitative easing program. The dollar hit a 12-year high against the euro a day later, with the USDX jumping north more than 3% in five trading days ending March 10. Remarkable, yes, but the USDX has the potential to climb even higher.2,3

Before this dollar bull market, we had a weak dollar for some time. A dollar bear market occurred from 2001-11, partly resulting from the monetary policy that the Federal Reserve adopted in the Alan Greenspan and Ben Bernanke years. As U.S. interest rates descended to historic lows in the late 2000s, the dollar became more attractive as a funding currency and demand for dollar-denominated debt increased.4

In Q1 2015, private sector dollar-denominated debt hit $9 trillion globally. Asian corporations have relied notably on foreign currency borrowing, though their domestic currency borrowing is also significant; Morgan Stanley recently researched 625 of these firms and found that dollar-denominated debt amounted to 28% of their total debt.4,5

So why has the dollar strengthened? The quick, easy explanation is twofold. One, the Fed is poised to tighten while other central banks have eased, promoting expectations of a mightier U.S. currency. Two, our economy is healthy versus those of many other nations. The greenback gained on every other major currency in 2014 – a development unseen since the 1980s.4

This explanation for dollar strength aside, attention must also be paid to two other critical factors emerging which could stoke the dollar bull market to even greater degree.

At some point, liabilities will increase for the issuers of all that dollar-denominated debt. That will ramp up demand for dollars, because they will want to hedge.

Will the dollar supply meet the demand? The account deficit has been slimming for the U.S., and the slimmer it gets, the fewer new dollars become available. It could take a few years to unwind $9 trillion of dollar-denominated debt, and when you factor in a probable rate hike from our central bank, things get really interesting. The dollar bull may be just getting started.

If the dollar keeps rallying, what happens to stocks & commodities? Earnings could be hurt, meaning bad news for Wall Street. A strong dollar can curb profits for multinational corporations and lower demand for U.S. exports, as it makes them more expensive. U.S. firms with the bulk of their business centered in America tend to cope better with a strong dollar than firms that are major exporters. Fixed-income investments invested in dollar-denominated assets (as is usually the case) may fare better in such an environment than those invested in other currencies. As dollar strength reduces the lure of gold, oil and other commodities mainly traded in dollars, they face a real headwind. So do the economies of countries that are big commodities producers, such as Brazil and South Africa.6

The economic upside is that U.S. households gain more purchasing power when the dollar strengthens, with prices of imported goods falling. Improved consumer spending could also give the Fed grounds to extend its accommodative monetary policy.6

How are people investing in the dollar? U.S. investors have dollar exposure now as an effect of being invested in the U.S. equities market. Those who want more exposure to the rally can turn to investment vehicles specifically oriented toward dollar investing. European investors are responding to the stronger greenback (and the strong probability of the Fed raising interest rates in the near future) by snapping up Treasuries and corporate bonds with longer maturities.

Stocks can still rally when the dollar is strong. As research from Charles Schwab indicates, the average annualized return for U.S. stocks when the dollar rises has been 12.8% since 1970. For bonds, it has been 8.5% in the years since 1976. A dollar rally amounts to a thumbs-up global vote for the U.S. economy, and that can certainly encourage and sustain a bull market.7

Mike Moffitt may be reached at ph# 641-782-5577 or email:  mikem@cfgiowa.com

website:  www.cfgiowa.com

Michael Moffitt is a Registered Representative with and Securities are offered through LPL Financial, Member FINRA/SIPC. Investments advice offered through Advantage Investment Management (AIM), a registered investment advisor. Cornerstone Financial Group and AIM are separate entities from LPL Financial.

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

There is a potential for fast price swings in commodities and currencies that will result in significant volatility in an investor’s holdings.

Citations.

1 – wsj.com/mdc/public/npage/2_3050.html?mod=mdc_curr_dtabnk&symb=DXY [3/9/15]

2 – reuters.com/article/2015/03/10/us-markets-stocks-idUSKBN0M612A20150310 [3/10/15]

3 – forbes.com/sites/maggiemcgrath/2015/03/10/u-s-equities-hammered-on-dollar-strength-and-oil-weakness/ [3/10/15]

4 – valuewalk.com/2015/02/us-dollar-bull-market/ [2/4/15]

5 – tinyurl.com/ptpolga [2/25/15]

6 – blogs.wsj.com/briefly/2014/12/24/how-a-strong-dollar-affects-investors-at-a-glance/ [12/24/14]

7 – time.com/money/3541584/dollar-rally-global-currencies/ [2/13/15]

 

After QE3 Ends

Can stocks keep their momentum once the Federal Reserve quits easing?

“Easing without end” will finally end.
According to its June policy meeting minutes, the Federal Reserve plans to wrap up QE3 (Quantitative Easing) this fall. Barring economic turbulence, the central bank’s ongoing stimulus effort will conclude on schedule, with a last $15 billion cut to zero being authorized at the October 28-29 Federal Open Market Committee meeting.1,2

So when might the Fed start tightening? As the Fed has pledged to keep short-term interest rates near zero for a “considerable time” after QE3 ends, it might be well into 2015 before that occurs.1

In June, 12 of 16 Federal Reserve policymakers thought the benchmark interest rate would be at 1.5% or lower by the end of 2015, and a majority of FOMC members saw it at 2.5% or less at the end of 2016.3

It may not climb that much in the near term. Reuters recently indicated that most economists felt the central bank would raise the key interest rate to 0.50% during the second half of 2015. In late June, 78% of traders surveyed by Bloomberg News saw the first rate hike in several years coming by September of next year.4,5

Are the markets ready to stand on their own? Quantitative easing has powered this bull market, and stocks haven’t been the sole beneficiary. Today, almost all asset classes are trading at prices that are historically high relative to fundamentals.

Some research from Capital Economics is worth mentioning: since 1970, stocks have gained an average of more than 11% in 21-month windows in which the Fed greenlighted successive rate hikes. Bears could argue that “this time is different” and that stocks can’t possibly push higher in the absence of easing – but then again, this bull market has shattered many expectations.6

What if we get a “new neutral”? In 2009, legendary bond manager Bill Gross forecast a “new normal” for the economy: a long limp back from the Great Recession marked by years of slow growth. While Gross has been staggeringly wrong about some major market calls of late, his take on the post-recession economy wasn’t too far off. From 2010-13, annualized U.S. Gross Domestic Product (GDP) averaged 2.3%, pretty poor versus the 3.7% it averaged from the 1950s through the 1990s.3

Gross now sees a “new neutral” coming: short-term interest rates of 2% or less through 2020. Some other prominent economists and Wall Street professionals hold roughly the same view, and are reminding the public that the current interest rate environment is closer to historical norms than many perceive. As Prudential investment strategist Robert Tipp told the Los Angeles Times recently, “People who are looking for higher inflation and higher interest rates are fighting the last war.” Lawrence Summers, the former White House economic advisor, believes that the U.S. economy could even fall prey to “secular stagnation” and become a replica of Japan’s economy in the 1990s.3

If short-term rates do reach 2.5% by the end of 2016 as some Fed officials think, that would hardly approach where they were prior to the recession. In September 2007, the benchmark interest rate was at 5.25%.3

What will the Fed do with all that housing debt? The central bank now holds more than $1.6 trillion worth of mortgage-linked securities. In 2011, Ben Bernanke announced a strategy to simply let them mature so that the Fed’s bond portfolio could be slowly reduced, with some of the mortgage-linked securities also being sold. Two years later, the strategy was modified as a majority of Fed policymakers grew reluctant to sell those securities. In May, New York Fed president William Dudley called for continued reinvestment of the maturing debt even if interest rates rise.7

Bloomberg News recently polled more than 50 economists on this topic: 49% thought the Fed would stop reinvesting debt in 2015, 28% said 2016, and 25% saw the reinvestment going on for several years. As for the Treasuries the Fed has bought, 69% of the economists surveyed thought they would never be sold; 24% believed the Fed might start selling them in 2016.7

Monetary policy must normalize at some point. The jobless rate was at 6.1% in June, 0.3% away from estimates of full employment. The Consumer Price Index shows annualized inflation at 2.1% in its latest reading. These numbers are roughly in line with the Fed’s targets and signal an economy ready to stand on its own. Hopefully, the stock market will be able to continue its advance even as things tighten.6

Mike Moffit may be reached at phone# 641-782-5577 or email: mikem@cfgiowa.com
website: www.cfgiowa.com

Michael Moffitt is a Registered Representative with and Securities are offered through LPL Financial, Member FINRA/SIPC. Investments advice offered through Advantage Investment Management (AIM), a registered investment advisor. Cornerstone Financial Group and AIM are separate entities from LPL Financial.

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.
1 – marketwatch.com/story/fed-plans-to-end-bond-purchases-in-october-2014-07-09 [7/9/14]
2 – telegraph.co.uk/finance/economics/10957878/US-Federal-Reserve-on-course-to-end-QE3-in-October.html [7/9/14]
3 – latimes.com/business/la-fi-interest-rates-20140706-story.html#page=1 [7/6/14]
4 – reuters.com/article/2014/06/17/us-economy-poll-usa-idUSKBN0ES1RD20140617 [6/17/14]
5 – bloomberg.com/news/2014-07-07/treasuries-fall-after-goldman-sachs-brings-forward-fed-forecast.html [7/7/14]
6 – cbsnews.com/news/will-the-fed-rate-hikes-rattle-the-market/ [7/10/14]
7 – bloomberg.com/news/2014-06-17/fed-will-raise-rates-faster-than-investors-expect-survey-shows.html [6/17/14]