The last week’s market highlights:
Quote of the week:
“Roll out those lazy, hazy, crazy days of summer/You’ll wish that summer could always be here.” – Nat King Cole
Each week, we present our featured topics in the context of the major themes listed below from the Nuveen Midyear Outlook:
- U.S. economy: Running ahead of its peers.
- Global economy: Trade a bigger concern outside the U.S.
- Policy watch: Central banks aren’t all on the same wavelength.
- Fixed income: Starting to prefer higher-quality assets.
- Equities: Earnings are supporting prices, but expect plenty more volatility.
- Asset allocation: Remain risk on, but focus on quality.
U.S. economy/Global economy: Risk “turns on” the dollar
The U.S. dollar has long been the world’s most widely traded currency. Because it’s also among the most popular destinations for investors seeking safety and liquidity in times of market stress, the dollar has often been considered a “risk-off” currency. It’s no surprise, then, that the greenback and U.S. stock prices diverged sharply during the 2008 financial crisis, for example, when bad news for stocks meant good news for the currency. What’s more, they remained negatively correlated—moving in opposite directions—over nearly all of the following eight years.
But in the fall of 2016, a powerful one-two punch transformed the dollar into a “risk-on” currency, at least for a while, as it rose in tandem with the S&P 500 Index. Markets began to price in a stronger U.S. growth outlook, pushing up U.S. interest rates and boosting the dollar. At the same time, prospects for higher corporate earnings growth brightened on better odds for corporate tax reform, which was passed in 2017.
We’ve seen a different dollar dynamic this year. In January, optimism over growth outside the U.S. fueled rallies in the euro, emerging-market (EM) currencies, and global equities, leaving the dollar behind. Over the next few months, though, markets turned skittish as protectionism driven by aggressive U.S. trade policy hurt sentiment. During these risk-off periods, investors returned to the relative safety of the dollar, once again crowning it “king.” Indeed, the correlation between the S&P 500 and the Federal Reserve’s Broad Dollar Index has been as negative over the past 12 months as it had been over the prior 12.
In fact, the strong dollar may be partly—or even chiefly—to blame for investors’ recently diminished risk appetite. Countries like Turkey have experienced currency-based panics, and this summer’s drop in the Chinese renminbi invited comparisons to China’s economic crises of 2015 and 2016.
Ultimately, we expect the dollar to decline from its elevated level against the euro and a number of EM currencies over the medium to long term. This would weaken the currency headwind that has hampered U.S. dollar-based investors this year. For example, the dollar’s strength has nearly tripled a 1.81% year-to-date loss for Europe’s STOXX 600 Index (in local terms) to 5.24% (in dollar terms). EM equities have declined 1.72% in local terms year-to-date but a far-worse 7.18% in dollars.
Fixed income: Treasury yields remain stuck
Last week, neither a series of solid economic data releases nor fresh record highs by the S&P 500 were able to shake Treasury yields out of their rangebound path. By finishing at 2.86% on August 31, the bellwether 10-year yield has closed between 2.82% and 2.89% for 16 consecutive trading days.
Likewise, continued gains in inflation had little effect. The Fed’s preferred inflation barometer, the PCE Index, edged up to 2.3% year-over-year in July, ahead of the Fed’s 2% target. Stripping out food and energy costs, core inflation reached a more than six-year high of 2%.
In non-Treasury markets, high-yield bonds delivered their ninth consecutive week of positive returns. In addition to benefiting from subdued issuance and strong U.S. equity market performance, the asset class has enjoyed steady fund flows.