What U.S. Dollar’s Recent Strength Means For Prospects

Brian Selzer

OCEAN CITY — One of our investment themes for this year has been the likelihood of an improving U.S. economy, accompanied by a stronger U.S. dollar. Second-quarter growth of U.S. gross domestic product (GDP) was just revised upward to 4.6% on an annualized basis, the largest quarterly gain since 2011.

Meanwhile, the U.S. dollar rallied more than 7% in the third quarter. This week, we examine the recent strength of the dollar, its impact on certain assets and expectations going forward.

The strength of the dollar can be attributed largely to better prospects for growth and inflation in the U.S. compared to other regions, coupled with a divergence in monetary policy from those of Europe and Japan. The

Federal Reserve (Fed) is expected to conclude its quantitative easing program this month. Our base case is that the Fed’s tightening cycle will be gradual and well-communicated, and that even after the first rate hike the central bank will have a reasonably long runway in normalizing rates. Meanwhile, growth in many other areas is wavering, and central banks are stepping in to boost their economies.

In September, in an effort to fight deflationary pressures, the European Central Bank (ECB) cut interest rates and its President Mario Draghi previewed a plan to purchase asset-backed securities and covered bonds issued by financial institutions. This is a reversal from recent years, which have seen the ECB shrink its balance sheet as the Fed did the reverse. These developments have caused the euro to depreciate by more than 7% against the dollar since the end of June.

The U.S. dollar’s move relative to the Japanese yen has also been significant, with the yen reaching the lowest level since 2008 amid a backdrop of accommodative monetary

policy. Beyond developed markets, a slowdown in China came as a surprise to the markets over the summer, as growth in industrial production slowed to an annual rate of 6.9% in August from 9.0% in July. These divergences in monetary policy and economic growth across global economies could continue to provide support for the U.S. dollar.

Traditionally a stronger dollar is bearish for commodities, and they have been a big casualty of the dollar’s recent surge, declining by about 12%2 since the end of June. Weaker growth prospects outside the U.S. have been a factor as well. With the Fed en route to tightening monetary policy and the resulting dollar strength it will be difficult for commodities to rally without a meaningful uptick in global growth, in our view.

The decline in commodity prices alongside the appreciating dollar has put the brakes on a rally in Emerging Market equities since spring. This outcome is unsurprising given the reliance of many developing economies on strong commodity fundamentals. We continue to favor a selective approach to Emerging Markets in the medium term, favoring areas that benefit from government reforms.

We are mindful that both the decline of commodities and the dollar’s rally may be getting stretched in the near-term. However, the moves are likely structural in nature. Sustained commodity rallies look unlikely due to slower economic growth outside the U.S. and expanding output, especially in the energy sector. Similarly, the U.S. dollar could remain firm due to the outperformance of the U.S. economy, along with the country’s improving fiscal health and transformative changes like the surge in domestic energy production.

Ultimately, a stronger dollar signals growing global confidence in U.S. assets and foreign capital inflows, contributing to further growth.

(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)

Consumer Spending Provides Unique Investment Choices

OCEAN CITY — With the U.S. stock market hovering near all-time highs, we advise being selective within equities to capture incremental performance. We believe consumer spending, long the bulwark of the U.S. economy and now close to 70% of gross domestic product (GDP), will continue to present both long- and short-term opportunities for investors. Looking out over the next few … Continue reading

Economy Confidence Could Lead To More Business Mergers

OCEAN CITY — With rising confidence in the economy, corporations are once again turning to mergers and acquisitions (M&A) to grow their earnings. In the U.S. alone, the value of the deals announced so far this year is around $1.4 trillion, up almost 70% from last year, according to Bloomberg. Along with growing cross-border M&A, this year has brought a … Continue reading

Emerging Market Equities A Top Performer This Year

OCEAN CITY — Emerging Market (EM) equities have significantly underperformed those of developed markets since 2009. After continuing to lag in the first quarter, however, EM equities have recently overtaken the U.S. as the top-performing region for the year so far, returning more than 11%. This move has come as a surprise to many, given the geopolitical concerns pervading the … Continue reading

Lack Of Market Volatility Biggest Surprise This year

OCEAN CITY — Of the surprises investors have encountered this year, none may be more significant than the lack of market volatility. By any measure and across most asset classes, volatility has not only remained at extremely low levels for most of the year despite numerous geopolitical concerns, but has continued to fall — trending this way since the summer … Continue reading

Commodity Investing Beyond Oil, Gold

OCEAN CITY — Broad commodity index prices are higher this year, along with those of equities and bonds. The growth reverses last year’s decline and stands in contrast to disappointing returns for commodities since prices of most asset classes bottomed in 2009. However, institutional investors continue to underweight commodities by about 15%, according to the latest Global Fund Manager Survey … Continue reading

Be Selective When Weighing Overseas Opportunities

OCEAN CITY — U.S. equities continue to hit all-time highs, causing some investors to become increasingly uneasy. International developed markets, on the other hand, still stand roughly 20% below their pre-crisis high. We favor European and Japanese equities, as relatively attractive valuations and accommodative money policies should provide tailwinds going forward. Investors should position themselves more carefully, however, given our … Continue reading

Counting On The Consumer

OCEAN CITY — The U.S. economy’s dismal first-quarter performance is now in the rear-view mirror, and we expect growth to pick up for the remainder of the year. Consumer spending, which accounts for 70% of gross domestic product (GDP) in the United States, is one of the driving factors. Our colleagues in BofA Merrill Lynch (BofAML) Global Economic Research expect … Continue reading