Let’s start with the performance elephant in the room: the greenback. Or maybe we should call it the red(hot)-back. Whatever you call it, the dollar’s soaring. It seems that rumors of its demise are once again exaggerated (or at least premature).
The Invesco DB US Dollar Index Bullish ETF (UUP), which loosely tracks the US Dollar Index, has taken flight this year. Even by 2022’s bullish standard, this week’s performance is unusually strong. UUP closed today’s session (Apr. 28) at its highest level in more than a year.
A key factor that’s ignited dollar buying: the Federal Reserve’s hawkish pivot on monetary policy. That coincides with relatively dovish expectations for the major currency counterparts in Europe, Japan and China. Each has different reasons for either favoring flat to lower interest rates in near term, or possibly lowering rates. The European Central Bank is the more hawkish position of the three (relatively speaking), and it may start to wade into the rate-hiking waters, slightly, later this year.
“A rate rise in July [for the Eurozone] is possible and reasonable,” says Martins Kazaks, Latvia's central bank governor. “Markets are pricing two or three 25 basis point steps by the end of the year. I have no reason to object to this, it's quite a reasonable view to take.”
For China, by contrast, expectations are building for rate cuts to support an economy that’s increasingly stressed by Covid lockdowns and other headwinds. Earlier this week, the country’s central bank said it will support the economy with targeted loans to small companies. The People’s Bank of China “will step up the prudent monetary policy’s support to the real economy, especially for industries and small businesses hit hard by the pandemic,” it said in a statement. Some analysts see rate cuts on the horizon as well.
Japan is another story. The central bank this week reaffirmed its commitment to maintaining low interest rates. The yen, not surprisingly, is taking it on the chin as a result.
It’s all a world away next to the aggressive rate-hiking that the Fed is expected to pursue in the months ahead following last month’s modest 25-basis-point increase. Fed funds futures are currently pricing in a series of rate hikes that may lift the current 0.25%-to-0.5% target rate range to as high as 2.0%-to-2.25% by the July FOMC meeting.
Bond markets, of course, are quick to reprice the shifting outlook for global yield differentials. Earlier this month, the US 10-year Treasury yield reached equivalence with China’s 10-year rate for the first time in a decade. No surprise, then, that the crowd is rethinking the relative value of the China bonds at a time when US rates are running higher and offering comparable yields, which look set to go even higher in the near term. Navigating the rapidly changing fixed-income landscape has been a problem for VanEck Vectors China Bond ETF (CBON), which continues to suffer.
US Treasuries are hardly a haven, although it’s interesting to note that iShares 7-10 Treasury Bond ETF (IEF) appears to be testing a bottom. It’s too early to go bottom fishing, but with US rates sharply higher this year the relative allure of Treasuries is starting to resonate. All the more so if US economic growth disappoints (as today’s Q1 GDP report did) and slows the Fed’s rate-hike plans.
Meanwhile, US consumer staples stocks continue to exhibit a bullish uptrend, offering a rare source of upside performance in the equities space
XLP’s counterpart, consumer discretionary shares (XLY), is having the opposite experience.
Finally, let’s close with a twist on playing the runup in inflation: ProShares Inflation Expectations ETF (RINF), which continues to post a strong uptrend. Tracking the FTSE 30-Year TIPS (Treasury Rate-Hedged) Index, the fund has been running hot this year. The question is whether the inflation trade is crowded and thereby vulnerable? The thought comes to mind as some analysts say that inflation is peaking. Sure, we’ve heard that before, but with trades like RINF running to extremes on the upside there’s little margin for error.
UBS this week laid out several reasons for thinking that inflation’s peak may finally be here (or near). “We are confident in the view that inflation is going to fall. The main question is how low the rate will go and how quickly,” the wealth management firm opines. ■