Words matter. No sooner had Steve Mnuchin, US Treasury Secretary, uttered the words (at Davos this week) “a weaker dollar is good for us as it relates to trade and opportunities” then the US dollar started to slide leaving it -2.6% against a basket of other currencies just this week. This comes on top of a -10% fall against the same currencies over 2017.
These moves weaker would seem to sit at odds with a rising rate environment, when higher yielding currencies generally are more attractive. It might point to the jitters that, for now, are well beneath the surface – jitters that the US will embark upon a series of trade wars and isolationist foreign policy, or jitters that all is not as it seems in terms of the strength of the economy and the robustness of growth.
This is the season when the major investment houses issue 2018 outlooks and an enduring theme throughout all of them has been the strong fundamental and technical factors underpinning synchronized global growth – as well as a belief that the recent tax reform in the US will prolong this positive momentum in markets for the next 12 – 18 months.
One group mentioned the explosion in liquidity across all asset classes – an explosion which has seen the total dollars in circulation from equities to high yield to other sectors growing by 500%. Against this expansion, the expected central bank tapering hardly makes a dent.
Inflation is broadly expected to rise, but not by much, and it was expected to reach targets (of around 2%) in the US, Japan and Europe, which would precipitate some rate rises there.
China is not much of concern either, as it appears that the administration there has been very successful at suppressing volatility, and will continue to do so, although growth may be more subdued and inflation may stimulate some interest rate rises.
One manager raised the interesting point that the current raft of tax reform and fiscal spending was a “shot in the arm that the economy didn’t need” at a time when growth was already robust and unemployment was at a low of 4.1%. It argued that just as Central Banks had run out of monetary bullets, this was likely to empty the fiscal toolbox, leaving no “dry powder” to stimulate the economy if it were to turn weaker. This does indeed give further credence to the current scenario being a “melt up”, in which the hangover could be significantly worse, the bigger the party.
Finally, some strategists have cited the remarkable coalescence of expert opinion around the status quo as itself being a concern – leading to a scenario where shock events are not properly discounted and few naysayers sit on the sidelines.
This Goldilocks scenario is suggestive of complacency and has already been shown to result in more volatility when markets are rattled. Thus far 2018 looks likely to have more volatility than 2017, where levels were historically low.