TGIF – Dollars and Sense

The US Dollar continues to slide to multi-year lows. It is never exactly clear why, but the potential for military combat in North Korea, the diminishing probability of another Fed interest rate hike and the increasing likelihood of the European Central Bank’s Quantitative Easing plan coming to an end are all contributing to the falling Dollar. Normally, with heightened geopolitical issues, investors around the globe flock to the Dollar for safety as the Universal Currency. That just isn’t happening now. As we all know, this environment is anything but normal. But Corporate America, with substantial revenues overseas, is really enjoying the weak Dollar. It makes American products much more attractive overseas.

The Euro jumped above $1.20 this week. That is the first time the European currency has seen that level since December of 2014. The Dollar and Euro were near parity as we started this year when the Euro touched $1.03. The Euro has surged 14% since, which is a really massive move for a currency. A strengthening European economy with low inflation is helping fuel the move. But European exporters are feeling the pain as American products are more attractively priced on the open market due to currency conversion. And that $350 a night hotel in Paris is now $420.

But it’s not just the Euro that the US Dollar has been losing ground to. The Dollar has also has been falling against the Japanese Yen, the British Pound, the Swedish Krona and even the Mexican Peso, which was battered off the Presidential election with debates about NAFTA and the Wall. Keep in mind, the Dollar spiked higher off the election results last November. Expectations of tax-reform and other pro-growth policies saw money from around the globe pour into Dollars. It peaked in January and has fallen ever since. At this stage, the prospects for comprehensive tax-reform this year are approaching zero. Even simple tax cuts appear unlikely in 2017. It seems like it’s been more of a move away from the Dollar rather than an aggressive move into these other foreign currencies.

Interest rates continue to fall too, with the 10-Year Treasury yield down to 2.06%, the lowest of the year. The Bond Market is telling us things are far from perfect. The yield curve is flattening, which does happen periodically, but is one of those signs to pay attention to. The 30-Year bond yield is down to 2.67% while the 1-Month bill is 0.96%. The front-end of the curve has been rising while the back-end has been shrinking. It is much healthier when the yield curve steepens. Think about it this way; would you want to take 20 more years of risk for just an additional 0.6% increase in income yield? For the vast majority, the answer is categorically no. But for insurance companies with liabilities who need to spread out reserves and foreign buyers looking to get money out of their country and get some yield with the currency conversion benefit, the answer is yes. Right now the spread between the 30-Year Treasury and the 1-Month is the tightest it’s been since 2007. For perspective the Yield curve inverted in 2006, more than a year prior to the stock market decline. We are still a long way from inverting now, but it is something we always keep a close eye on.

In July, the Market was pricing in a greater than 50% chance of another interest rate hike by year-end. Now it’s assigning just a 31% probability, and shrinking daily. The US economy continues to grow at a very sluggish pace and inflation remains benign. The thinking is why raise when there is little risk of an overheated economy. Most representatives at the Fed are in the dovish camp. That means they are cautious with monetary policy and prefer to provide support until it is absolutely clear it is no longer needed. The Market has known this all along since 2008 and has rather enjoyed the magic Fed elixir. This week the Vice Chairman of the Federal Reserve, Stanley Fischer, announced he will step down in October. This was an interesting and rather unexpected event, but it actually has us thinking that it enhances the chances that Janet Yellen stays as the Fed Chair when her term is up in February. But right now February seems like a long way away.

Looking under the hood, this Market has some issues that need addressing. It’s what a correction is all about. The Bond Market is the smartest of markets. It’s telling us that September into October should provide more turbulence. There’s just some weird stuff going on which has us on guard. We’re on it and we have your back.

Have a nice weekend. We’ll be back, dark and early on Monday.


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