After being one of the biggest beneficiaries of the reflation trade following the election of Donald Trump, King Dollar was dethroned in the first quarter -- falling against every major currency tracked by Bloomberg.
A strong dollar tends to have a negative effect on credit growth globally, a key impetus for an increase in economic activity. A lofty greenback also raises the cost of servicing dollar-denominated debt held abroad. As such, its retreat reflects firming growth outside the U.S. and serves as a source of support for the global expansion.
The dollar hasn’t been weaponized yet by any measures intended to encourage domestic production, namely, a border adjustment tax, and the cost of hedging dollar obligations has been trending lower.
Oil Breathes Life into Inflation, Drilling Activity
West Texas Intermediate oil prices have rallied over the past two weeks as major OPEC and non-OPEC producers indicated their willingness to extend production cuts. The stabilization in prices has helped crude-producing regions in North America find their footing. It also provided a jolt to market-based measures of inflation expectations and has supported other commodity prices, reducing fears about bond defaults in the energy and materials sectors.
In Canada, the worst of the shock has clearly passed -- the country’s economic surprise index recently hit its highest level since 2010 amid job growth that’s exceeded analysts’ expectations for seven consecutive months. In the U.S., the rise in prices has bolstered the fundamentals behind the pick-up in the number of active rigs.
Stocks Say EMs Doing Better Than U.S.
Benchmark U.S. equity indexes remain within reach of all-time highs as earnings expectations climb, reflecting the anticipation that the long American expansion hasn’t reached its expiration date.
However, segments of the market expected to be key beneficiaries of fiscal changes sought by the Trump administration, such as infrastructure stocks and banks, have lagged the broader market.
The rally in emerging-market indexes suggests the backdrop outside the U.S. has improved by more than it has domestically, a testament to the reflation trade’s global foundation.
"We are seeing EM stocks outperform U.S. equities," writes Neil Dutta, head of U.S. economics at Renaissance Macro Research. "This indicates improving growth outside the U.S."
A More Realistic Curve
Differences between yields on short- and long-term U.S. Treasury bonds have declined from post-election peaks as investors temper expectations surrounding how much pro-growth fiscal policies can be expected to buoy domestic activity.
The spreads between two- and 10-year Treasury yields, as well as the gap between the five- and 30-year maturities, closer reflect the expectations of relatively modest growth and inflation that have guided the market since the global financial crisis, rather than the risk of a reflationary boom under Trump’s pro-growth policies.
"Reflation expectations got ahead of themselves, and we’ve seen a retracement of that," said Michael Dolega, senior economist at Toronto-Dominion Bank. "Some of this is probably linked to soft data that came in way above expectations, but hasn’t materialized in the hard data yet"
Even so, Dolega said he doesn’t expect a falter yield curve will be a sufficient disincentive for the provision of providing credit, anticipating more constructive rate and regulatory environments for lenders going forward.
Gold turned in a stellar first-quarter performance, as rising inflation expectations buoyed the appeal of the precious metal. The rally has continued into the second quarter even as those expectations ease.
The trade faltered Wednesday for the first time this week as ADP data on job growthadded to signs of strength in the U.S. economy and bolstered the outlook for a steeper interest rate increase path for the Federal Reserve.
The Japanese yen, another asset that tends to gain when market participants are risk-averse, also turned in a strong first-quarter -- but that advance may soon falter.
Currency strategists at Morgan Stanley contend the currency’s strength relative to the greenback is "unsustainable and is likely to be reversed within the coming weeks," pointing to a more hawkish Fed and a looming rise in hedging costs. In addition, a bevy of technical indicators suggest the yen is due to retrace its gains.