Catching a falling knife is never a good idea. A strong dollar (USD), moderation of GDP and earnings growth estimates are happening at the same time as global economies continue to increase fiscal and trade imbalances.
The collapse of emerging market currencies from a modest reduction in Fed balance sheet and small rate rise shows the extent of the imbalances built by many economies in the QE years. As USD strengthens and capital flows turn to the US, emerging market debt refinancing becomes more challenging.
US dollar strength and gold divergence is interesting. It seems that the market is pricing a disinflationary outcome of the global slowdown - as gold is usually an inflation hedge - and a flight to safety.
A strong dollar is a positive sign for America because:
- High added-value doesn’t need devaluation. US exports 12% of GDP.
- Higher purchasing power for savers and salaries enable better consumption.
- It attracts capital, making Treasuries and US investments more attractive and safer for global investors.
US growth improved in June, particularly strong vs weakening China, Eurozone and Emerging markets.
June ISM Manufacturing Index rose to 60.2 vs China and Eurozone.
PMIs show the evidence of global slowdown. Manufacturing PMI in June 2018:
- China 51.0 vs 51.5 in January
- Eurozone 54.9 vs 59.6 in January
- Japan 53.0 vs 54.8 in January.
USD strength has a lesser impact on profits:
- Technology, high-margin, high added-value firms are more than 27% of S&P 500.
- US exports are less than 30% of S&P revenues. Corporate profits correlation with the USD is not very strong at all. US profits mostly suffer when oil rises.
- Stronger dollar means more inflows into US assets and Treasuries with a rate hike path confirmed.
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