The outcome of the US/China trade negotiations remain key for the near to medium term outlook on markets. The US dollar is a key mover on this. We look at how this is impacting on the outlook for forex, equities and commodities.
Markets move on relatives. How one country performs relative to another? In forex, interest rate differentials (i.e. one country’s bond yields relative to another) are key. It affects the carry trade. Is one yield moving higher or lower relative to another? On 30th January, the Fed shifted its monetary policy as it hit the pause button on rate hikes, opting to be more “patient”. Since then, the US 10 year yield has fallen by around 5 basis points. A dovish move that should be dollar negative, you would think. However, the dollar has strengthened decisively, with the trade weighted Dollar Index rallying from c. 95.5 to 97.1 (over 1.5% higher). EUR/USD has fallen from $1.15 to below $1.13, and USD/JPY rallying from 109 to 110.5. How could this be? Markets are taking a view that if the Fed is turning cautious when the US economy is holding up so well, what does this mean for central banks such as the ECB and the People’s Bank of China who are presiding over proper slowdowns? The 10 year Bund yield has fallen 10 basis points to a new two year low. Perhaps the US Government shutdown has played a curious role here as US economic data has been unable to be released during a time in which growth indicators of the Eurozone and China have suffered. Whether the US economy is really such an outlier will all come out in the wash in the coming weeks as the bottleneck of US data is released. However, US retail sales gave a glimpse of weakness last week and if this is not such a rogue data point, the relative strength of the dollar may begin to struggle for traction.