A long weekend is in prospect in the U.S., to end what has been a quiet month on the markets (outside of cryptocurrencies). In such circumstances it's easy to miss something important. For the last Points of Return in May, here are some trends that might have been too easy to miss.
The Dollar at a Crossroads
Two months ago, the dollar was rallying, and touched its 200-day moving average, suggesting that it was ready to break higher. Technical analysis matters a lot in the foreign exchange markets, and that moment helped traders decide that they weren't prepared to take it higher. Now the dollar is at another possible parting of the ways. If the currency drops further from here, it sets a new seven-year low, and strengthens the belief that it is now in a secular downturn:
The last big sea change, in late 2014, came as oil tanked amid extreme dissension at the Organization of Petroleum Exporting Countries. As crude is priced in dollars, they tend to move in opposite directions. The recent strengthening of the oil price has contributed to dollar weakness. But it is more about the central argument that has coursed through markets for months: Is inflation really on the way back, and if so will it bring higher rates with it? Increased borrowing costs would tend to attract money into dollar-denominated assets and strengthen the currency. The mini-peak came a couple of months ago when the inflation trade was at its peak and everyone was braced for a repeat of the 2013 "taper tantrum," when yields shot higher as the Federal Reserve tried to prepare the way for a gradual removal of asset purchases. Since then, the bond market has calmed down somewhat. Kit Juckes of Societe Generale SA suggests that it might be best to assume the tantrum has already happened:
US 10-year yields rose from a low of 1.4% in 2012, to 3% during their tantrum. In this cycle, the rise has been from 0.5% to a high just below 1.8%. That's comparable in relative terms. The eventual peak in US yields in 2018 was 3.25%. Can't we accept that the taper tantrum has already happened? The important difference is that in the tantrum cycle, core CPI never got above 2 ½%. A bet on further bond weakness is a bet on inflation proving to be stickier than the Fed can cope with.
A bet on bond weakness (with higher yields) would also be a bet on a stronger dollar. At present, investors seem reluctant to place such a wager, which could point to protracted dollar weakness.
Another factor is the strength of the recovery in the U.S. It matters whether this is inflationary. It also matters whether the recovery is stronger than in other countries, which at present seems likely. If so, then it is fair to expect the returning U.S. consumer to demand more imports. That would widen the U.S. trade deficit and require net sales of dollars for importing currencies, meaning it would weaken the dollar, all else equal. This chart from Longview Economics Ltd. of London shows the closeness of the relationship:
In the long term, a deepening deficit would help cyclical sectors of the stock market, while the weakening dollar would in itself be inflationary (by increasing the dollar price of imports) That would mean growing inflationary pressure in the U.S., and would tend to prompt capital to go elsewhere. An unbalanced international recovery could end up weakening the dollar. This is Longview Economics' view:
Our view is that the cyclical/value reflationary sectors of the global stock market will outperform over coming years. That sector rotation should be driven by rising bond yields as markets price in growing inflationary pressures in the US economy. As such, capital will favour non-US markets, and drive a sustained phase of dollar weakness.
Then there is China's influence. All unnoticed, the Chinese yuan has appreciated significantly, and has now regained all the ground it lost amid the "trade war" tariffs of late 2018. With the exception of a brief period in early 2018, it hasn't been this strong since the infamous devaluation of August 2015, marked in the chart. With investors increasingly looking to China for the cue while the Western world seems becalmed, further strength for the yuan would translate into broader weakness for the dollar:
Another way to put the relationship between China and the dollar involves the commodity market. When China is booming, demand for raw materials tends to be higher, and so a strong yuan and strong commodity prices tend to go together. Since the 2015 devaluation, the following chart shows that the yuan has very much followed resource prices:
The recent rally in metals is widely regarded as evidence of a strong cyclical recovery. If investors believe in that story, the impact on the Chinese and U.S. currencies is another way in which global reflation could translate into a weaker dollar.
Will investors have the appetite to take the dollar lower? It looks to be one of the critical questions to answer in June. On balance, we should prepare for a major period of dollar weakness — unless the next raft of data shows that inflation really does take off in the U.S. and forces the Fed into tightening earlier than it wants.
Good News from Greece
It hasn't been much heralded, but Greece seems to have regained the trust of international investors. That is another way of saying that the euro zone is deemed more likely to survive.
What follows is a chart of a relationship that many of us grew accustomed to scanning anxiously every day for years at the beginning of the last decade: the spread of Greek over German government 10-year bond yields. This basic measure of country risk exploded higher in the early years of the European Union's sovereign debt crisis, and spiked again during the Greek government's disastrous attempt to call the EU's bluff over further bailouts in 2015. Having topped an incredible 30 percentage points at the end of 2011, the spread is now down to only one percentage point. After much excruciating and unnecessary pain, Greece has righted its ship:
The tragedy of the Greek economy over the last decade has been intense. Everyone (not just Philhellenes like me) should be glad about this recovery. But if there is one cause for concern, it is that the euro zone has more political heat ahead of it. With Mario Draghi, the European Central Bank chairman who virtually saved the euro singlehandedly, now installed as Italy's premier, the greatest political risks of a split have abated. But you never want to rely on Italian political stability. And the politics of the two nations at the center of Europe are uncertain. Germany chooses a chancellor not named Merkel later this year, and France decides whether to give Emmanuel Macron another term early next year. Investors may be a little too relaxed about the prospects for the European project.
Why Americans Are So Angry
A fascinating report from the University of Chicago's Becker Friedman Institute includes some terrifying data on gender and generational inequality in the U.S. The ugly political environment grows easy to understand. This is what has happened to median lifetime earnings, in real terms, for American men over the last 65 years. By the late 1960s, those entering the workforce could expect to earn considerably more over their career than those who started a decade earlier. But after that, it was downhill. Those who started work in the early 1980s, and might now be hoping to retire, made no more in real terms than those 30 years older:
This isn't good. The decline in male earnings is is in part because of the entry of women to the workforce. This has had the effect of drastically narrowing the gender gap (intensifying male disaffection), while still leaving a huge imbalance in their favor (which will understandably leave women still feeling the victims of injustice):
The report is worth reading in full, and not only because it shows the scale of the discontent in the U.S., even though its macroeconomy seems to have grown steadily over the years. Interestingly it also shows that much of the increase in inequality of recent years, and the decline in opportunities for men, can be traced to inequalities when they enter the workforce. Education matters. That leads to another important issue that it's been easy to ignore.
A report just out from the ratings agency Standard & Poor's shows that demand for U.S. university education dropped sharply in the academic year that is now ending. Of course, the pandemic will have had huge effects that may well prove to be transitory, but the numbers are stark:
Many institutions, particularly in the private sector, saw a sharp fall in the number of students enrolling. With demand declining, as I have covered recently, universities have also moderated increases in tuition fees, which have dropped below 1% on an annual basis for the first time in decades. This adds up to a nasty economic problem for U.S. higher education. The higher-rated (in terms of their credit) institutions tended to maintain enrollments relatively better, according to S&P, implying that plenty of lower-rated colleges and universities face financial difficulties. This isn't great, and shows the difficulties of managing a university's finances.
Add to this the difficulties for the many endowments that have a heavy investment in real estate, and don't have the usual rental income this year to help them through, and this could be a troubling time for universities. That in turn doesn't augur well for efforts to turn back inequality.
As a long weekend beckons, it might be a good time to catch up on podcasts. One I'd like to recommend is this one from the Cautionary Tales podcast by my former colleague Tim Harford. It tells the sad story of how some basic problems with Excel spreadsheets cost thousands of lives last year in the U.K. as public officials lacked the right information. If you want something more musical and whimsical for listening to in a hammock, maybe try the Kinks' much-underestimated Village Green Preservation Society album. Have a good weekend, whether or not it's a long one.
John Authers is a senior editor for markets. Before Bloomberg, he spent 29 years with the Financial Times, where he was head of the Lex Column and chief markets commentator. He is the author of "The Fearful Rise of Markets" and other books.
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement