Soft US Dollar Helping Propel Crude Oil, Gold, Equities
- Prospect of extended low rates helping riskier assets.
- With FX volatility edging higher again, it's the right time to review risk management principles to protect your capital.
Think back to January: the Federal Reserve had said that it intended on raising rates up to four times this year, despite the fact that global economic data was worsening. This caused quite a bit of consternation for market participants, who quickly pushed the US Dollar higher, Crude Oil lower, and US equities plunging.
Today, we're in a diametrically opposite situation in markets. The Fed is backing off of its hawkish impluses, with Fed Chair Janet Yellen this week highlighting concern over both sides of the dual mandate (sharply declining payroll growth and longer-term inflation expectations eroding). Forget four rate hikes this year - markets are barely pricing in one rate hike by December. And so, we find the US Dollar lower, Crude Oil higher, and US equities sitting less than 1% from their all-time highs.
The most pronounced moves we've seen today are directly related to the Fed. First, with rates now expected to stay on hold through year-end, market participants are frontrunning the low growth, low inflation environment by piling into core European debt. Now that German yields are below -0.40% (the depost rate threshold for QE-eligible bond purchases) through 5-years (on approach to 8-years), we wouldn't be surprised to see the German 10-year bund turn Japanese - that is, go negative itself. Second, with the yield backdrop for the US Dollar eroding, USD-denominated assets like Crude Oil (CFD: USOIL) and Gold (CFD: XAU/USD) have jumped over the past few days. Crude Oil itself just achieved the $50.91/51.06 target we outlined back on April 12, highlighting the pickup in risk sentiment the past seven weeks.
This is what QE and the prospect of lower rates of longer does to market participants: it shifts their investing behavor vis-a-via the portfolio rebalancing channel effect. With Fed rate expectations collapsing precipitously over the past week thanks to Friday's abhorrent May labor market report, investors have been quick to recalibrate to the reality that the Fed liftoff isn't coming until at least September, but more likely December - which means that risk assets take on a whole new light in the near-term.
--- Written by Christopher Vecchio, Currency Strategist
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