Risk assets are recovering well as investors continue to position for de-escalation in the Middle East. The return to equity markets and to pro-growth and higher-yielding EM currencies has led to a broadly softer dollar. However, we question whether conditions are right for a sustained dollar decline just yet, when assessing factors like Fed policy, global growth and any evidence that foreign investors are quietly leaving US asset markets or increasing dollar hedge ratios.
On the Fed, last night saw the release of the Beige Book ahead of the 29 April FOMC meeting. This showed economic activity flat to modestly expanding, with the K-shaped dynamic in full swing. Lower-income households were feeling the strain, while higher-income spending remained resilient. The labour market seemed to be holding up well, while on pricing, the survey showed that input costs were rising more quickly than selling prices. This was generating margin compression. In all, it points to a Fed comfortable with the policy rate at 3.75%, where neither the labour market is deteriorating nor are second-round inflation effects growing. The case for renewed Fed easing has yet to be made, although the whole world will be glued to Kevin Warsh’s confirmation hearing next Tuesday for any dovish plans.
On the subject of global growth, it is tough to see markets overlooking the headwinds which have been created over the last month. Energy prices look higher on a sustained basis (though this is not as large a shock as 2022), while interest rates, unlike currencies, have notably failed to retrace any of their moves in March. These tighter financial conditions have to prove a brake on global growth, which will likely emerge in hard data over the coming months.
As to the subject of volatile policymaking out of Washington causing investors to reduce concentration risk in US asset markets or increase dollar hedge ratios, evidence is scant. Last night’s release of US TIC data for February showed the foreign private sector buying $147bn of US long-term securities in February, the highest since last September. Equally, we have an article here suggesting that instead of causing the dollar sell-off during January/February’s Venezuela/Greenland news, the European buy-side used the cheaper dollar to decrease their dollar hedge ratios.
Barring some negative headlines out of the Middle East, risk assets should stay mildly bid and the dollar mildly offered today, but we don’t see conditions in place for DXY to make an immediate return to the lows of the year at 96. We have a couple of Fed speakers today and the weekly initial claims data, though these look unlikely to move markets.
Chris Turner
