Cross-Asset Dispatches
A Fistful of Dollars
How inconsistent is the market’s bullishness on the dollar and risk assets? We find less so than popular perception would suggest.
Dollar strength… You can’t keep a good trade down. After struggling in 1H14, the Greenback has strengthened considerably on the back of increasing growth and policy divergence with the rest of the world. It’s a trend our FX strategists expect to continue.
…leads to a conundrum: Dollar strength is a widely cited risk for markets, yet investors look positioned for both the dollar and risk assets to push higher. Is this inconsistent?
What does history tell us? Periods where both the dollar and US 2-year rates have moved higher have generally been good for both equities and credit. It’s the dollar strength when the 2-year is falling (i.e., ‘risk-aversion’) that is bad for returns.
What could be different this time? We summarise a number of our strategists’ insights into the impact of a stronger dollar. We think that EM equities and credit could struggle more under a strong dollar than history suggests, given increased USD borrowing and less leverage to improving US growth.
Is recent price action a dress rehearsal? Expectations of a stronger dollar and somewhat tighter dollar liquidity don’t make us bearish, but do contribute to a skew for DM over EM across our portfolio. Differentiation is key, of course, as weakness has opened up pockets of value in EM local rates and FX.
Trades for the theme: We highlight a number of ways to improve exposure and risk/reward against a backdrop of dollar strength.