Today’s jobs report was a major disappointment for job creation, but a major victory for longer-term risk-on investors. Today is the classic day when fundamentals and market technicals intersect so it is especially important to listen to the signals broadcast from the FX markets this morning:
Takeaways: The dollar has likely peaked. Developed and emerging markets (EM) markets are likely going to perform better in the future. The Fed is likely to ease.
The Technicals:
- The US dollar has been trading near the top of a multi-year trading range and has failed to break-out on the upside (Figure 1).
- On an intermediate term basis, the US dollar, as measured by the DXY, has been in an uptrend since the start of 2018 that is being broken today (Figure 2). If the US dollar continues to fall meaningfully through these levels, it increases the probability of an 8%+ correction as measured by DXY. This sell-off would take DXY to the bottom of its multi-year trading range. This would be very positive for foreign currency investments, and the relative attractiveness of foreign stocks.
- Foreign currencies are stronger across the board (Figure 3)
- Interest rate differentials often drive FX markets. Today is an important potential inflection point on this matter as well. The interest rate spreads between 10-year German bunds and 10-year Treasury bonds peaked in 2018. While it remains high, that spread has been contracting since the second half of 2018. Today, it is threatening to break the long-term trend of wider interest rate differentials. This would be a notable development and could suggest that a meaningful trend towards tighter spreads between US and German bonds is in place (Figure 4).
The Fundamentals:
- The May jobs report showed the US economy only produced 75k new nonfarm jobs. The front end of the Treasury curve (in particular the relationship between 2-year notes and Fed Funds), has been predicting an easing for some time. Now, the economic data is giving the Fed reason to act as well. Lower Interest rates support higher equity market valuations, are a stimulant to the housing market, and provide pro-growth support to the economy.
- FX investors like to own currencies tied to central banks that are raising rates, and now that the Fed is increasingly likely to ease, these FX traders are selling the US Dollar.
- The dollar is falling today against all of the G-10 Currencies. FX traders smell a weaker US economy, a worried Fed, and an easing. A weaker dollar takes pressure off of the global financial system, especially EM nations that often must repay their debt in US dollars. This trend likely will support stability in EM economies, EM stock markets, and EM FX.
Bumps in the Road:
- Tariffs
Figure 1: Currency Returns
Source: Bloomberg, accessed 6/7/2019
Figure 2: 10 Year US Treasury, 10 Year German Bund
Source: Bloomberg, accessed 6/7/2019
Figure 3: US Dollar (Historical)
Source: Bloomberg, accessed 6/7/2019
Figure 4: US Dollar (1/5/17 – present)
Source: Bloomberg, accessed 6/7/2019
Jonathan E. Lewis
Chief Investment Officer
