Treasury prices are little changed this morning amid a better tone in risk markets. S&P 500 futures are currently up 13 points on reports that a Chinese delegation is flying to Washington to resume low-level trade negotiations, which is contributing to a weaker U.S. dollar for the first time in more than a week. Trade tensions are receiving the bulk of the blame for recent dollar strength and subsequent volatility in emerging markets, but current Fed policy may be the elephant in the room. The rally in the dollar since early April has corresponded with the acceleration of Fed balance sheet reduction (and continued Fed rate hikes). Less dollar supply from Fed tightening (including BS reduction) increases commodity costs, which sparks inflation risks in emerging markets even if growth is stagnant. This is not a new phenomenon, but the game is different this time around given the unwind of a massive asset purchase program (QE).
As we have noted several times in recent months, it would be unreasonable to believe that QE could drive global stock/bond prices higher for several years while purchases were being made but not have any inverse effect on the unwind. Any tightening cycle is a difficult balancing act for a central bank, evidenced by the fact that the Fed has only achieved one soft landing (no recession) in the modern era. Add the unwind of an unprecedented bond purchase program to what was already a difficult process, and you end up where we are today. I’m not saying it’s not doable, but I certainly don’t envy their position. The positive is that U.S. growth fundamentals remain positive, but can the U.S. economy withstand rising stress in the global economy?
Jason Haley
Managing Director, Investment Management Group