Economists more sceptical that Europe can keep growing at last year’s pace while recent Japanese economic data has been mixed
The dollar is rallying again after floundering for most of the past year, another sign that global growth momentum may be shifting back to the U.S. and away from other major economies.
Signs of stronger U.S. economic growth and inflation are becoming a central focus of financial markets, helping lift the dollar to its highest level since January. Yields on the U.S. 10-year Treasury note last week crossed over 3% for the first time since 2014, evidence that part of the economy is returning to more normal conditions after a long stretch when bonds yields had hovered near historic lows.
The U.S. economy grew at 2.3% in the first quarter, according to government data released on Friday, expanding faster than the 1.8% analysts were expecting. A rise in the employment-cost index also signalled rising wages, analysts said. If Friday’s closely watched jobs report shows wage growth approaching 3%, as it did in January, that could provide more support that inflation may be beginning to stir.
Economists, meanwhile, are turning more sceptical that Europe can keep growing at last year’s pace. Recent data like German manufacturing and weaker Eurozone inflation have signalled a slowdown. U.K. growth also eased in the first quarter, while recent Japanese economic data has been mixed.
“Many people were bearish on the dollar because they thought the rest of the world was doing quite well,” said David Woo, head of global rates and currencies at Bank of America Merrill Lynch. “It’s very clear that this theory has been severely challenged.”
The bank recently urged investors to bet the euro will decline to $1.15 in coming months, from around $1.21 Friday.
In Friday’s trading, the Dow Jones Industrial Average was flat, and stocks were slightly down for the week following one of the busiest periods of the first-quarter corporate earnings season. Investors will be watching next week for earnings from blue chips like Apple Inc. and McDonald’s Corp.
When the dollar was weakening, analysts were puzzled why the interest rate differential between Treasurys and foreign bonds didn’t support a stronger U.S. currency. But now that dynamic may be playing out. The gap between U.S. 10-year Treasury yields and those on German bunds is at its widest since 1989, according to DWS.
With investors increasingly believing the Federal Reserve may raise interest rates four times this year, that spread could continue widening and offer additional dollar support.
The WSJ Dollar Index rose 1.1% last week, its best weekly-performance since 2016, and the dollar ranks as one of the currency market’s top performers in April. Last year, the dollar fell 7.5% as investors came to believe that growth would accelerate faster abroad as the U.S. economy reaches the end of its cycle.
Dollar bulls have another reason for hope. The futures market is still highly skewed against the U.S. currency, with the largest bearish dollar position since 2011 earlier this month, according to data from the CFTC. Further dollar gains could force some of those investors to cover their bets and buy back the dollar, pushing it higher.
Rising yields are making it expensive to remain short the dollar, as investors have to borrow in the U.S. currency to bet against it, said Ugo Lancioni, head of global currency at Neuberger Berman.
A rising dollar has broad implications for markets and the economy. While it can attract more foreign capital to U.S. bond markets, it can bruise the earnings of U.S. multinationals by making their products less competitive abroad. Around 60% of companies reporting first quarter results said that dollar weakness had helped boost their earnings, according to FactSet data gathered in mid-April.
Facebook said last week that “foreign exchange tailwinds” contributed $536 million to its first quarter revenue, while pharmaceutical company Bristol-Myers Squibb also indicated favourable foreign exchange dynamics provided a 4 percentage point boost to revenue.
Some investors believe the dollar rebound could prove temporary. For one, the U.S. economy is later in the economic cycle and the European Central Bank has barely begun tightening its monetary policy. Analysts expect the ECB to make a decision in June or July to phase out the bond-buying program by December—four years after the Federal Reserve halted its own quantitative-easing program.
Moreover, many analysts also believe the dollar’s bullish and bearish cycles tend to last between five and seven years, on average. That would mean the U.S. currency is in the early stages of an extended period of decline, after a bull market that began in 2011 and peaked in early 2017.
But a temporary dollar rally can last months, even in the midst of a bear market period. That is what happened during a seven-year dollar slump during the previous decade: in 2005, the dollar rose 13% over 11 months, before returning to a downward trend the following year.
Some think growth momentum will likely shift back to Europe in the coming months, spurring the ECB and other central banks to continue normalizing monetary policy.
The dollar’s move “is a bear market rally,” said Jason Draho, head of tactical asset allocation Americas at UBS Wealth Management.
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