International | May 12 2017
Kathleen Gaffney, Co-Director of Diversified Fixed Income, Eaton Vance notes that the Federal Reserve has raised interest rates twice in the past six months and another hike in June is seen as a strong probability. However, the U.S. dollar has been weaker in 2017, which has some investors scratching their head.
She adds:
It's not a surprise to us, based on the global economy and the change in world order we see today. We believe the dollar could continue to decline against its currency rivals even if the Fed continues to move toward a tightening stance.
The market currently seems to have a view that the dollar is going to continue to strengthen, mainly because of the Fed's recent quarter-point rate increase and the hawkish language that accompanied it. But consider that Europe, along with the U.S., appears to be in an expansionary mode. This is evidenced by recent Purchasing Managers' Index (PMI) data as well as sharp acceleration of new orders in manufacturing. German inflation has risen to just below the 2% target level. Even Japanese labor markets are tightening. The stimulus that has been available via monetary policy is finally more evident in developed economies.
And while China's growth has been slowing as of late, it is holding at a healthy level. There has been downward pressure on commodities. However, we believe this is more of a result of targeted credit tightening in the more speculative property markets.
Assuming other major economies are in growth mode along with the U.S., it's unlikely that flows into the U.S. dollar can continue at the same pace with that kind of competition from other currencies. We are likely to see convergence in terms of rate hikes and growth all around the globe. Broader strength around the globe takes the pressure off of the dollar. Rhetoric out of the European Central Bank and Bank of Japan, while remaining accommodative, shows these central banks are no longer willing to commit to additional stimulus. Once the market perceives that there is potential for a change in trend, capital will be less inclined to search for yield.
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Moreover, there is a political aspect to this forecast. The current global political environment contains a strong populist mandate for stronger growth. We are likely to witness a transition from monetary policy to fiscal policy driving the market, and in the U.S. the focus is on bringing back jobs and manufacturing. That's going to be tough to do if the dollar continues to climb, especially given its significant rise over the past couple of years (see figure above).
The uncertainty about the new administration's ability to deliver is also weighing on the credibility and stability of U.S. foreign policy. While it is hard to think of a global super power losing its position in the global theater, we may be experiencing a period of decline and challenges for democracy. We are hopeful that vacuum is being filled by a new younger generation – Trudeau in Canada and Macron in France. Additionally, many emerging market countries are raising their status by putting through more effective reforms.
Bottom line: For reasons driven by our more optimistic view of world growth and the current political climate, we think that the dollar is less likely to appreciate as much as the market is predicting. That means non-dollar currencies look more attractive to us.
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Eaton Vance (NYSE: EV), is a leading global asset manager whose history dates to 1924. With offices in North America, Europe, Asia and Australia, Eaton Vance and its affiliates managed US$363.7 billion in assets as of January 31, 2017, offering individuals and institutions a broad array of investment strategies and wealth management solutions. The Company's long record of providing exemplary service, timely innovation and attractive returns through a variety of market conditions has made Eaton Vance the investment manager of choice for many of today's most discerning investors. For more information about Eaton Vance, visit eatonvance.com.
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