What the Rising Dollar Says About Global Growth

Investors were happily betting on a synchronized global upswing, but that trade risks unwinding as economies appear to diverge

By Richard Barley

Citigroup economic surprise indexes 

Source: FactSet

Was it just a mirage? The stronger, more synchronized growth in the world economy that powered markets in 2017 has faltered at the start of 2018. As that has become ever clearer in recent weeks, the U.S. dollar has rebounded suddenly and surprisingly. The uncomfortable reality is that economic, financial and monetary-policy cycles are in very different places around the world.

On the growth side, Wednesday’s first-quarter eurozone gross domestic product data confirmed a slowdown, with annualized expansion falling to 1.7% from 2.7% in the fourth quarter, well below the 2.3% pace recorded by the U.S. Emerging-market growth appears to have softened too, early in 2018. 
The expectation last year that global central banks were all moving toward ending their extraordinary monetary policy may be proven premature. With U.S. inflation perking up, the Federal Reserve appears to be the only central bank pursuing that path, although it isn’t expected to move on Wednesday.

Ten-year government bond yields


Others are looking more hesitant. The Bank of Japan has abandoned its attempt to predict when inflation will reach 2%. In the U.K., weak data has led analysts to abandon the belief that the Bank of England will raise rates next week. And the European Central Bank is still waiting for signs of sustained inflation; some analysts are starting to wonder if the exit from bond purchases might not come in 2018 after all.

Global interest rates are diverging further, rather than converging. Remarkably, the two-year U.S. Treasury yield is well above that on 30-year bonds in Germany, the U.K. and Japan. The gap between 10-year U.S. and German yields has reached its widest in 29 years.
Printed sheets of dollar bills are aerated at the Bureau of Engraving and Printing in Washington, D.C. Photo: Jacquelyn Martin/Associated Press 

As long as there was a belief in the accelerating global growth story, investors confidently made trades like betting on a rise in the euro against the dollar. That trade got crowded, leading to the rapid, painful rebound in the dollar in the past month. The future of global growth has got harder to read as well. Bad weather may have caused the slowdown in Europe, for example.

What has become clear is that growth and inflation will remain on track in the U.S. That will force investors to focus on continued tightening by the Fed. The concern is that monetary policy will be tightened too much, ending a long-running U.S. expansion, even before other central banks have really got off the launchpad.

The more worrying scenario is if last year’s synchronization was more a matter of the economic stars aligning briefly, with faster growth masking the differences between regions of the world.

If U.S. growth continues to diverge from elsewhere, then U.S. bond yields might rise further, and the dollar could gain more ground. The global growth consensus—and popular trades based on it, such as emerging-market stocks and bonds—would face a challenge.

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