The coronavirus and the stock market sell-off forced the Fed to cut rates. While falling rates is one outcome, from an asset allocation perspective it is especially interesting to see the sharp sell-off in the US Dollar that has occurred in recent days. Since the summer of 2018, the US dollar (as measured by the US Dollar Index) was in a broad trading range of 94 to 100. With US stocks surging in the first weeks of the year, the dollar was surging too. In fact, it looked as though the dollar was going to break-out from this trading range and trade much higher. However, coronavirus, fears of a slowdown, and now a Fed rate cut have changed expectations about the dollar and it is now falling sharply. It has fallen into the middle of the trading range and below its 200-day moving average. This dollar weakness highlights an important point about the sell-off in stocks and the rally in bonds. If US stocks are going down while the dollar is going down, it seems likely foreign investors are leaving the US, and not coming here for a safe haven. Since February 21st, when stocks began to roll-over in a noticeable way, the Japanese yen has moved up 4% against the dollar, and the euro is up about 3%. The Swiss franc is up more than 2% as well. Often in stock market panics we see a surge in the dollar as global investors move to the US as the world’s safe haven. It’s important to think about the reasons foreign investors are choosing not to invest in the US and what it means at this time. These reasons likely include rising fears of political risk in the US, unattractive yield opportunities, and a concern the impact of the coronavirus on the US has yet to be seen.
If we try to draw larger conclusions from these patterns, it seems reasonable to conclude that foreign investors are selling dollars, and mostly funding these sales from their equity sales. To the extent foreign investors are buying bonds, it is likely more modest than the demand from domestic investors.
With the Fed cutting rates and the trend of falling rates in the US, foreign investors might re-allocate to their home countries given the currency risk. This means support for the US bond market now is likely narrower from domestic investors, at a time when the budget deficit is moving up sharply.
A comparative review of February bond data is informative: while intermediate Treasuries were up 1.66% in February, the rest of the bond market has not participated in the same way. Intermediate corporates were up 0.99%, and intermediate municipals were up 0.72%. When non-Treasury investors begin to put on the brakes, as the comparative performance data shows, it’s worth noting. Bond buyers seem to be saying that the coronavirus can impact corporations and local governments in terms of their earning power and revenue generating capacities in ways that do not impact the US government. Stock investors have said this since late February in a very clear and unambiguous manner – bond buyers are only beginning to think about these consequences in how they express their views. In some ways, there is more clarity in stocks now than in bonds. In stocks, everything is down. In bonds, all sectors went up in value, just by varying amounts.
This is the first Fed surprise rate cut in many years and we believe it’s a clear signal the Fed intends to do whatever it takes to increase asset values. So far, the Fed cut seems to not be having an impact, so we could expect more monetary and fiscal stimulus to come. In an election year, it would be expected for a president seeking reelection to stimulate the economy.
We believe the Fed formula is straightforward now: higher stocks increase consumer confidence and that is good for the economy. Fiscal policy will likely soon turn stimulative too. In our opinion, for the time being, this continues to be a time for capital preservation in bonds (especially Treasuries), keeping risks minimal, with risk-taking opportunities growing more attractive in other asset classes.
Jonathan E. Lewis
Chief Investment Officer