A month to forget?
IN 2016 we witnessed a terrible start to the year; the worst ever. This year for the first half of the month it was all going well: the FTSE All-share index was up 1.4 per cent by January 12, admittedly somewhat behind the spectacular rise in the S&P 500 of 4.2 per cent, but nevertheless reasonable. By the end of January, the S&P had made further progress ending up 5.6 per cent higher, but the All-share index saw a fall of 1.9 per cent over the month. Some of this can be attributable to the uncertainty that is dominating the UK economy with Brexit and the subsequent below par forecasts for economic growth.
Taking a step back the most important move during the month was the steady increase in US Treasury bond yields, with the 10-year yield moving from 2.4 per cent to 2.7 per cent, the highest level for four years. The strong US economy has led to fears that the yield on Treasuries would move higher than had been expected, prompting the equity sell-off. There appears to be a sense of relief a couple of weeks on, that the markets are calming down and that the terrific rise in volatility has largely failed to spread to other asset classes. This is despite signs of a continuation in rising inflation in the US and more rises in US bond yields; last week they continued to creep upwards, reaching 2.9 per cent.
In the middle of all of this the one market that appears to be behaving out of character is the US dollar. It is usually the case that the dollar gains in times of volatility, as investors flee to the perceived safety of US assets, but it now stands at its lowest level since 2014. It is also a little strange, as usually the currency follows yield differentials. The logic is that if a country has higher yields, international investors will prefer to put their money there, thus pushing up the currency. This is clearly not the case currently, as the yield differential between the US and Germany has widened and yet the dollar has weakened. The US economy is booming by all reports, which should attract money rather than turning it away.
The explanation as to why it is happening is not obvious. The first possibility is that China is influencing the dollar by buying fewer US Treasuries, thereby pushing yields up and leading to a weaker dollar. In turn this strengthens their currency, which may be attractive to the authorities as China still has a sizeable trade surplus. Secondly, the view amongst international bond investors may be to avoid the US as they see inflation rising and therefore consider yields should be higher. It is a complex situation but one that is clearly important: US dollar strength has a far-reaching impact on a global basis.
It is very difficult to see the way forward at the moment: one higher than expected statistic had a significant impact on markets globally and it is a little hard to shake off the feeling that it is all a little tenuous.
:: Cathy Dixon is a director at the Belfast office of Cunningham Coates Stockbrokers, a trading name of Smith & Williamson Investment Management ( SWIM). This article does not constitute a recommendation to buy or sell investments and the value of any shares may fall as well as rise. Investments carry risk and investors may not receive back the amount invested. The views expressed are those of the author and not necessarily of SWIM.