Rising U.S. Rates And A Stronger Dollar: Tectonic Shifts For Investors As Fed Changes The Game Plan
Markets are in disarray after Fed Chairman Ben Bernanke’s magic trick, pulling the tablecloth from the dinner table without moving a single plate. Talk of the Fed tapering its program of quantitative easing has clearly created a gulf in the way investors see monetary policy in the U.S. versus other major central banks, which are ramping up their monetary easing. The U.S. dollar, which experienced a broad sell-off on Wednesday, appears to have entered a longer-term structural uptrend, while yields on 10-year U.S. Treasuries have shot up in May, hitting their highest levels since early-2012. It may be too early to position for the longer-term just yet, but flow dynamics and the resilience of the U.S. consumer suggest the tide is beginning to change.
These are major tectonic shifts, and, while they may not give investors direct cues as to short-term positioning, they clearly drew the battle ground for the longer-run. The U.S. dollar is strengthening, and there’s little people can do about it as long as the world’s largest economy continues to outpace is peers.
The market has sniffed this economic strength, Nomura’s currency Jens Nordvig explained, which is even more extraordinary in the face of fiscal restraint and the sequester. The U.S. dollar has generally outperformed major FX crosses, commodity currencies, and emerging markets, despite Wednesday’s weakness. The greenback is now up more than 6% this year, a major move for the global reserve currency.
Aggregate U.S. dollar longs on the CME hit $39 billion last week (before the large yen washout), and are approaching levels seen in the summer of 2012, when the greenback rallied sharply and then fell precipitously. Portfolio equity flows in the U.S. are also picking up, even as major central banks like the Bank of Japan, the Reserve Bank of Australia, and the European Central Bank have eased monetary policy to stimulate growth. And gold, once seen as a safe-haven, has fallen dramatically and currently trades below $1,400 an ounce.
Markets may have overreacted to Bernanke’s comments (at the end of the day, he made it clear they aren’t tightening yet, and even in the face of tapering would leave economic conditions extraordinarily easy), yet the moves in interest rates should push investors to take into account their positioning over the next three to five years, Barclays ’ research team explained. The yield on 10-year Treasuries have jumped 34 basis points since last May 22 when Bernanke addressed Congress, as investors reconsider the Fed’s intention to keep QE going while eyeing nice yearly gains in the S&P 500.
Resiliency is the best way to describe the U.S. consumer, which, along with housing, have helped secure a relatively decent economic performance. Consumer confidence hit a five-year high in May, while home prices continue to rise. Shares in homebuilders like KB Home and PulteGroup have remained near 52-week highs for quite some time, while consumer discretionary has been a solid S&P 500 sector, with big players like Walt Disney and Ford Motor delivering sweet returns in 2013.
It seems like it’s all a matter of timing now, as Barclays’ research team notes. It is difficult to set positions for the long-term as volatility is expected to remain. Fiscal restraint in the U.S. promises to continue to rear its ugly head, obstructing growth and throwing off stocks. The Bernanke Fed has made it clear that it plans to respond to incoming data, increasing or decreasing asset purchases to reflect underlying conditions. Europe remains a conundrum, and major EMs like China and Brazil are exhibiting weakness. What is clear, though, is that the game has changed, at least in terms of investor perception, when it comes to monetary policy in the U.S. and elsewhere.
Agustino Fontevecchia, Forbes Staff