Weak dol­lar: A green light for global stocks rally

IN­VEST­MENT FO­CUS

Kuwait Times - - BUSINESS -

Far from in­di­cat­ing the US econ­omy is strug­gling or the “Trump dis­count” un­rav­el­ling, the weak dol­lar may be a sign that ar­guably the most be­nign in­vest­ment con­di­tions for a decade are likely to per­sist a while longer.

US stock mar­kets are at record highs, with the S&P 500 in­dex up a solid 10 per­cent this year, and mea­sures of volatil­ity have never been lower. At the same time, the dol­lar is down 10 per­cent this year and at 15-month lows against a bas­ket of ma­jor cur­ren­cies. With the dol­lar as the world’s main fund­ing cur­rency, in­vestors had wor­ried un­til re­cently that the twin forces of US in­ter­est rate hikes and a strength­en­ing dol­lar would de­rail the rally in global stocks.

Be­fore this year’s drop, the dol­lar had posted its best three-year rolling per­for­mance against its cur­rency bas­ket in more than three decades. A stronger dol­lar in­di­cates tight­en­ing global fi­nan­cial con­di­tions. Con­versely, as Mor­gan Stan­ley says in a note, a 2 per­cent dol­lar de­cline is equiv­a­lent to a 25 ba­sis point cut in the US fed­eral funds rate in terms of im­pact on fi­nan­cial con­di­tions.

The green­back’s 8 per­cent fall since April has also co­in­cided with a de­cline in ex­pec­ta­tions of US rate in­creases fu­el­ing an ex­tended rally in global stock mar­kets. This week, the blue-chip Down Jones In­dus­trial Av­er­age scaled a peak of 22,000 for the first time. While doubts about US Pres­i­dent Don­ald Trump’s longevity in the White House or his abil­ity to pass key re­forms have also been cited as head­winds, there is a grow­ing be­lief that the dol­lar is re­flect­ing the rude, in­fla­tion-less health of an ex­pand­ing world econ­omy.

“As­set mar­kets and the dol­lar are re­act­ing to the same thing which is a Goldilocks (not too hot, not too cold) pe­riod for the global econ­omy along with a cau­tious Fed that will con­tinue,” said Ka­mal Sharma, a direc­tor of G10 FX strat­egy at Bank of Amer­ica Mer­rill Lynch in Lon­don.

In­vestors say the dol­lar’s de­cline has fur­ther to run as it re­mains broadly un­der­val­ued and that this may fuel fur­ther gains in as­set mar­kets. An In­ter­na­tional Mon­e­tary Fund re­port pub­lished last week said the dol­lar re­mained over­val­ued by more than 10 to 20 per­cent based on US eco­nomic fun­da­men­tals. JPMor­gan’s in­dex track­ing the dol­lar’s val­u­a­tion against an in­fla­tion­ad­justed bas­ket of its peers was still near its long term me­dian.

The lat­est leg of the dol­lar’s drop also comes as the eco­nomic out­look be­yond the United States has bright­ened con­sid­er­ably, par­tic­u­larly in the euro zone, en­cour­ag­ing in­vestors to bet on fur­ther weak­ness in the US cur­rency.

Derek Halpenny, head of Euro­pean global mar­kets re­search at MUFG in Lon­don, said the ra­tio of un­hedged to hedged pas­sive in­flows into Euro­pean eq­ui­ties has surged since the French pres­i­den­tial and par­lia­men­tary elec­tions, in­di­cat­ing in­vestors are more com­fort­able in tak­ing for­eign cur­rency ex­po­sure while buy­ing as­sets. Though those flows have de­clined from their highs, fund man­agers re­main bullish about the sin­gle cur­rency’s out­look, link­ing it to an im­prov­ing econ­omy and the prospect of pro-growth re­forms.“A bet on the euro is a bet about French labor re­forms rather than any per­ceived ECB hawk­ish­ness and if that goes through, EUR/USD can go above 1.20,” said James Kwok, head of cur­rency man­age­ment at Amundi As­set Man­age­ment in Lon­don. In an­other sign of grow­ing risk ap­petite, emerg­ing mar­ket eq­ui­ties have seen 20 con­sec­u­tive weeks of in­flows while debt funds have seen 27 straight weeks of in­flows, ac­cord­ing to Bank of Amer­ica Mer­rill Lynch flow es­ti­mates. De­spite the rel­a­tively heavy spec­u­la­tive euro bets by hedge funds, large in­sti­tu­tional play­ers such as cen­tral banks and pen­sion funds re­main un­der­weight the euro and re­lated as­sets, sug­gest­ing they could in­crease ex­po­sure to the sin­gle cur­rency.

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