How America’s blockbuster stimulus affects the dollar

Stronger growth and higher rates should mean a stronger greenback

Here is the tale of the dollar so far in 2021. 

It came into the year on a declining trend. 

A lot of people were mildly chary of its prospects. 

The gist was that people had bought a lot of dollars last year. 

They might wish to sell some. 

There has since been a dramatic upward revision to forecasts for gdp growth in America. 

This has been mirrored in sharply rising Treasury yields. 

Growth upgrades; higher interest rates; both are good for currencies. 

The result has been a stronger dollar.

It is not sufficient for a strong dollar that America does well; others must also be doing badly. 

“If the us economy grows incredibly fast and nowhere else does, the dollar will go up,” is how Kit Juckes of Société Générale, a bank, puts it. 

The question is: can it keep going up and for how long? 

The dollar usually provokes strong feelings in the currency fraternity. 

It is either loved or hated. 

That is not the case now, which is remarkable. 

There may be a strong-dollar story. 

But there is no really strong story about the dollar.

To understand why, consider first the important drivers of currency moves: trade flows, relative interest rates and risk appetite. 

Trade flows track the underlying demand for a currency. 

If domestic interest rates rise relative to foreign ones, that attracts speculative capital inwards, supporting a currency. 

Shifts in risk appetite can overwhelm these fundamentals. Indeed that was the story in 2020. 

Last March, when suddenly the priority was to have cash, the cash that people wanted was dollars. 

The dxy index, a weighted average of the dollar’s exchange rate against six other widely traded currencies, rose sharply in mid-March, as covid-19 panicked markets. 

The Federal Reserve responded by opening swap lines with other central banks to ease the dollar shortage. 

Then, over the rest of the year, the dollar declined, as risk appetite revived.

The greenback’s bounce-back this year is more about interest-rate differentials. 

Here the story gets a little frayed. 

The interest rates that you would normally think of as mattering for speculative currency flows are short-term rates. 

But central banks are not for moving those soon. 

So bond yields have become a signifier, since they in part reflect the as-yet-distant tremors of moves in future short-term rates. 

Bond yields in turn are responding to growth expectations. 

The dollar responds by moving higher.

After all, what currency would you swap it for—the euro? America’s economy is roaring back, while much of euro-land remains closed, and the distribution of vaccines has been (how to put it charitably?) sluggish. 

You can make a case that the Federal Reserve will have to tighten monetary policy sooner than it thinks. 

But the European Central Bank looks set to keep interest rates near zero indefinitely. 

The same goes for the Bank of Japan. 

Britain’s vaccination programme has been a success, which helps explain the rising pound. 

But Britain remains locked down and its economy is still suffering. 

Rising crude prices have pushed up the currencies of big oil producers, such as Canada and Norway. 

But beyond these, there are few currencies you might prefer over the greenback.

The dollar seems likely to rise a bit further in the near term. 

“There are a lot of stale short-dollar positions,” says George Papamarkakis of North Asset Management, a hedge fund. 

Speculators who have a bearish view of the dollar have already sold it short. 

If the currency keeps rising, they may be forced to buy it back. 

Another factor in the dollar’s favour is that risk appetite is less ravenous than it was. 

Equity markets are choppy. 

The dollar might be the least-worst place to sit out the volatility. 

And if the financial markets suffer a full-scale tantrum, the greenback could benefit from a flight to safety.

Later in the year, though, there is a case for a mildly weaker dollar. 

A big part of that story is that a booming American economy will lead to a wider trade deficit: strong demand in America will spur activity elsewhere. 

Asia is already doing well. 

Europe is lagging but will enjoy an upswing once vaccination rates pick up. 

Risk-taking would then revive. 

“When the us is doing well, and also bringing the world with it, there are more interesting places for investors to put their money,” says Mr Juckes.

As the days grow longer, 2021 might start to look less like early 2018, when a faster pace of interest-rate increases in America drove up the dollar, and more like 2017, a year of broad global growth and a falling dollar. 

The story of the greenback in 2021 could yet have a twist.

As Covid Wanes, the U.S. Economy Could Soar. What That Means for Investors

By Ben Levisohn

             Photo Illustration by Neil Jamieson

Everything we heard about Covid-19 was true. 

The novel coronavirus has killed millions of people around the world, left others seriously impaired, and turned even the simplest acts, like hugging our loved ones, into potentially deadly encounters.

Yet everything we heard about Covid-19 was also wrong, at least in relation to the economy and financial markets. 

Exactly one year ago, as the virus began to spread across the U.S., the economy effectively shut down, leaving more than 20 million people unemployed and sending the stock market into a tailspin. 

But quick and dramatic actions by the Federal Reserve and the U.S. government, and the development of vaccines in record time, not only helped to avert a second catastrophe, but also led to one of the swiftest economic recoveries on record and successive stock market highs. 

With the lifting of Covid-19 restrictions just about in sight, America itself could be on the cusp of a new beginning.

The combination of trillions of dollars of fiscal stimulus, ultralow interest rates, and a newfound sense of liberation means the U.S. economy in coming months will be unlike any the country has experienced in decades. 

Growth will be faster. Inflation will run hotter. 

The job market could bounce back more speedily than even the Fed expects. 

This environment won’t be easy for investors to navigate, as a likely rise in interest rates and a rebound in economically sensitive stocks could diminish the lure—and performance—of stocks that worked so well in 2020, including highflying tech shares, work-from-home plays, and speculative special-purpose acquisition vehicles, or SPACs. 

For those who can pivot as the market shifts, however, multiple opportunities await.

Embracing the changes ahead requires an understanding of what so many investors got wrong a year ago. 

From its peak on Feb. 19, 2020, to its trough on March 23 of that year, the S&P 500 index tumbled 34%, cementing the swiftest bear market on record. 

The decline reflected what had become obvious by the time the World Health Organization declared a pandemic on March 11: The U.S. economy was facing a full stop that would cause one of the largest drops in gross domestic product in the nation’s history—and quite possibly, another depression.

To avert this worst-case scenario, as Barron’s declared on its March 23, 2020, cover, the government had to step up in a big way. And it did, defying numerous skeptics.

The Federal Reserve cut interest rates to near-zero, and then reinstituted financial-crisis-era policies, such as quantitative easing, in a matter of weeks, before going even further and buying corporate bonds. 

The central bank’s moves kept the markets liquid and the cost of borrowing cheap. Congress, meanwhile, passed the Cares Act, which pumped $2.2 trillion into the economy by extending and increasing unemployment benefits, sending checks to most Americans, and allowing the Fed to lend money to small businesses.

These responses weren’t perfect, but they didn’t need to be. Importantly, they dwarfed the policy moves made during the financial crisis of 2008-09, and sent a strongly positive signal to business and the financial markets. 

“You don’t fight the Fed when it’s fighting a pandemic,” says Edward Yardeni, president of Yardeni Research. “I get the sense that the only regret that the Fed and fiscal policy makers have is that they didn’t do this in 2008.”

Investors also underestimated human ingenuity. 

Early estimates put the development of a successful Covid-19 vaccine somewhere around the summer of 2021, but with the help of the government’s Operation Warp Speed, the first shots were developed and approved before the end of 2020. Now, they are making their way into millions of arms across the country. 

At the same time, the technological advances made in the past decade, including the ability of many to seamlessly transition from the office to working at home, meant that parts of the economy could keep functioning almost as if nothing had changed.

In the chaos of the moment, it was easy to miss what seems obvious now. Many investors believed that the stock market would resume falling after a reprieve in mid-April. 

History even suggested as much. The market plummeted following Lehman Brothers’ bankruptcy in September 2008, then staged a massive end-of-year rebound, and then turned down again. Other bear markets have followed a similar pattern.

But last year’s bear market wasn’t just another bear market. Unlike the market meltdown of 2008, which was sparked by a financial crisis, or even that of 2001, caused by excessive dot-com valuations combined with the terrorist attacks of Sept. 11, 2001, and the run-up to the second Iraq war, 2020’s plunge owed to a black-swan event, or exogenous shock. Yet history shows that recessions and bear markets caused by so-called sudden stops rarely last long, says Barry Knapp, managing partner at Ironsides Macroeconomics.

The Asian flu, for instance, caused the S&P 500 to tumble 20% over three months in 1957, before recovering fully. “The failure to look at historical analogues was the greatest mistake people made last March,” Knapp says. “It’s a huge shock, but a quick shock.”

The same could be said of the Covid-19 recession. U.S. GDP tumbled 10.2% from the peak at the end of 2019; four quarters later, it is off just 1.2%, and should hit a new high during the first quarter of 2021. 

The unemployment rate fell to 6.2% last month from a peak of 14.8% in April 2020—a decline that took 10 months. 

During the financial crisis, GDP slid just 3.3% from its peak, but took seven quarters to recover. 

Joblessness, which peaked at 10% in October 2009, didn’t decline to 6.2% for another 54 months.

In contemplating the Covid-19 downturn, “most people were thinking it would be a long, deep recession and a slow recovery,” says Michael Darda, chief economist at MKM Partners. 

“Instead, the recession was deep but short, and growth will really be picking up now with the reopening.”

As economic activity resumes, consumer spending should provide a big boost. Americans are sitting on lots of money, and are about to get more: U.S. consumer net worth hit a record $130.2 trillion at the end of the fourth quarter of 2020, up 23.3% from the level in the corresponding 2018 period, and Congress just approved another round of stimulus, checks for most Americans, this time $1,400. “We have never seen the consumer emerge this strong from a recession,” says Chris Harvey, head of equity strategy at Wells Fargo Securities.

Harvey recently recommended buying consumer-services stocks. Examples would be McDonald’s (ticker: MCD), Starbucks (SBUX), and Yum! Brands (YUM).

President Biden signed a $1.9 trillion stimulus bill on March 11, a further step toward bolstering the U.S. economy. / Mandel Ngan/AFP/Getty Images

U.S. GDP grew 4.1% on an inflation-adjusted basis in last year’s fourth quarter. Economists are forecasting a gain of 4.5% in the current quarter—compared with projections of 4% at the end of 2020—and 4.7% for the full year. Add expectations of 2% inflation, and nominal GDP growth could total 6.7% for all of 2021.

But even those forecasts could be low, says Mike Wilson, chief U.S. equity strategist at Morgan Stanley. The firm sees growth of 8.1% in 2021, well ahead of the Fed’s 4.2% forecast. 

“The Fed will react to the data after the fact,” says Wilson, who expects the 10-year bond’s yield to hit 2% by the end of the year. “The markets will move ahead of the Fed.”

One doesn’t have to accept that view to know that the 10-year Treasury yield is too low in relation to economic expansion—and just about every other asset class. Nearly all have regained their prepandemic levels. 

The S&P 500 is up 16% from its February 2020 peak; the Nasdaq Composite has gained 36%. Oil prices, which went negative last April, are trading at their highest level since April 2019, while the copper price has surged to levels last seen in 2011. 

Even after its recent jump, the 10-year Treasury yield, at 1.62%, is still 0.30 of a percentage point below the level at which it started 2020.

A rise in the 10-year yield to 2% could shave 10% to 15% off the S&P 500’s price/earnings ratio. The good news for investors is that the decline in P/Es can be offset by earnings gains. That’s why Wilson has a price target of 3900 on the S&P 500, essentially unchanged from Friday’s close.

“The most mispriced market in the world is for the 10-year Treasury yield,” says Wilson. “It will have a major impact on what you can pay for assets.”

Investors have already gotten a taste of what some are calling “regime change” in the bond market, when a quick 0.7-of-a-point rise in the 10-year yield caused the Nasdaq Composite to drop nearly 11% from its peak on Feb. 12 through March 8. Stocks such as Tesla (TSLA) and Apple (AAPL), and other tech titans tumbled even more.

In contrast, shares of companies that do well when economic growth quickens and inflation expectations rise soared. 

The Energy Select Sector SPDR exchange-traded fund (XLE) gained 19%; the Financial Select Sector SPDR ETF (XLF) advanced 8.3%, and the Industrial Select Sector SPDR ETF (XLI) rose 4.6%.

Barron’s said a year ago that policy makers would “have to get creative” to avert an economic catastrophe. They did and, as a result, better times await.

As the recovery continues, investors will do best to buy not simply the cheapest stocks, but also those of companies that can out-earn analysts’ estimates. 

The focus on earnings will be particularly acute, given that 40% of S&P 500 companies had rescinded or stopped giving guidance during the crisis, resulting in a wider range of forecasts than usual from analysts.

At the same time, operating leverage should start to kick in. As the economy perks up, and as GDP estimates rise, profit forecasts should, too. “Once earnings-per-share estimates are revised upward, we anticipate further positive [estimate] revisions,” Harvey says. “Stocks will follow earnings revisions higher.”

The sectors with the largest increase in profit forecasts since the end of 2020 are materials, financials, and energy, at 8.4%, 9.7%, and 47.7%, respectively. All three are getting a boost from the economy’s comeback. To track the recovery in real time, Credit Suisse created a cyclical-acceleration index, which incorporates changes in Treasury yields, high-yield-bond spreads, and commodity prices. 

The firm also offered a basket of stocks positively correlated to changes in the index and that should outperform the market if the post-Covid economy lives up to its potential.

Stocks that make the list include energy companies Devon Energy (DVN) and Pioneer Natural Resources (PXD), materials concerns Mosaic (MOS) and Nucor (NUE), and financials Discover Financial Services (DFS) and Ameriprise Financial (AMP).

Pharma stocks, too, could rally after years of investor neglect.

Just don’t make the mistake of expecting a short-lived rally in these industries. Covid-19 accelerated the use of technology, from videoconferencing to cloud-based data, by old-economy companies around the world. 

That should translate into faster earnings growth and better profit margins, meaning that economically sensitive and heretofore unloved sectors should shine in the years ahead.

“The benefits of the decadelong investment in the cloud will accrue to users of tech from producers,” says Ironsides Macro’s Knapp.

Even so, big technology stocks should continue to do well, supported by their issuers’ massive cash flows. But highly priced, speculative shares, such as those of Tesla and Zoom Video Communications (ZM), could struggle.

The next year could be bumpy for the country and the stock market—and, yes, the novel policies employed to stave off disaster could sow the seeds of a future financial crisis. But the arrival of vaccines and the beginning of an economic resurgence suggest that the year ahead will also bring renewed hope and happiness, and not only for investors.

A tantalising glimpse of a post-vaccine world

Countries are beginning to map out the path to a new normal

The editorial board

Outdoor dining and socialising return to Israel, where around 4m of the 7m population are now fully inoculated © Menahem Kahana AFP via Getty Images

First, Americans had Dolly Parton singing of vaccines to the tune of “Jolene” to encourage them to get the jab (“I’m begging of you, please don’t hesitate/ ’cause once you’re dead then that’s a bit too late”). 

Now they have a further incentive. 

The Centers for Disease Control and Prevention this week said fully vaccinated adults could meet each other or people at low risk of contracting Covid-19 indoors, without social distancing or masks. 

If Americans needed any more impetus, they could look across to Israel, whose population is celebrating after its superfast vaccine rollout led to most restrictions being lifted, or disregarded.

For locked-down citizens elsewhere, the US and Israeli moves offer enticing glimpses of a post-vaccination world. 

Yet the US guidelines, in particular, prompted surprise elsewhere. 

In the UK, which has vaccinated a bigger proportion of its adults than the US, distancing rules remain in place for all. 

England’s chief medical officer warned this week the virus could surge again in autumn, long after inoculations are supposed to be completed.

The CDC argued it was important to spell out how life could begin to return to normal. 

The benefits of reducing social isolation for the vaccinated outweighed the risks, it said, and might “help improve . . . vaccine acceptance and uptake” among the hesitant. 

Social distancing and mask-wearing have also met more resistance in the US than anywhere; with infections still raging, governors in Texas and Mississippi have lifted statewide mask requirements for all — which President Joe Biden called “Neanderthal thinking”.

In Israel, 4m of its nearly 7m adults are fully vaccinated, with a further 1m awaiting their second shot. 

The rest are deemed unlikely to get the jab, through scepticism or perceived lack of need. 

The government’s laissez-faire approach to enforcing remaining restrictions may partly reflect the fact that it is facing another election on March 23, the fourth in two years. 

But, while it is pondering how to persuade sceptics to get jabs, the government appears to be following a tacit policy of monitoring hospital admissions while being ready to let the virus circulate among the young unvaccinated.

Other governments may in time opt for a similar approach. 

One reason for maintaining measures such as mask-wearing even with vaccinations well under way has been uncertainty over whether jabs prevent transmission as well as infection. 

Evidence is slowly mounting that they do. 

Israel’s health ministry found shots were 94 per cent effective at preventing symptomatic infections, and 89 per cent against infections of any kind, including those without symptoms. 

If little or no virus can be detected, many scientists assume it cannot be passed on.

The big threat to the “dream” scenario of governments being able to ease restrictions almost entirely as inoculation programmes end is the emergence of new variants that resist existing vaccines or cause worse symptoms and higher hospitalisations even among the young and healthy. 

Later rounds of jabs — booster shots against mutated strains — seem inevitable. 

Testing programmes may be needed for some time to hunt down new variants, and as an alternative to “vaccine passports” for those who cannot or choose not to be jabbed.

Little by little, however, outlines of the post-pandemic normal are becoming discernible. 

Rich-world governments that are making good progress with vaccinations now need to prepare to donate their surplus doses to the developing world — to ensure they are not the only ones that can enjoy that brighter future.

Turkey Reaches Out to Central Asia

Turkey's cultural ties to this region give it an opening.

By: Geopolitical Futures 

For Turkey, the Turkic-speaking countries in Central Asia and the Caucasus present an opportunity to spread its influence into a critical Russian buffer zone. 

Turkey has long had a presence in Azerbaijan, a close ally in the Caucasus that Ankara supported in last year’s Nagorno-Karabakh war. 

But Ankara’s ambitions are bigger. It wants to expand its reach farther east into Central Asia, with the hopes of forming a sort of alliance with the other Turkic-speaking countries: Kazakhstan, Uzbekistan, Kyrgyzstan and Turkmenistan. 

These post-Soviet states, however, also have close ties to Turkey’s historic rival, Russia.

Turkey’s economic presence in Central Asia is fairly modest; it’s not a top trade partner for any of the states in the region, save for Turkmenistan. 

But Turkey is slowly trying to build an economic and cultural basis for cooperation and even plans to create a common market for goods, investment, labor and services by 2026-28. 

Earlier this month, Turkish Foreign Minister Mevlut Cavusoglu visited Turkmenistan, Uzbekistan and Kyrgyzstan and discussed a number of issues, including energy, trade and transport, with his Central Asian counterparts. 

He also said his country was working with Uzbekistan on a preferential trade deal and free trade agreement.

The countries of Central Asia prefer to remain as neutral as possible; memories of their not-too-distant past in the Soviet Union still loom over their foreign relations today. 

But Turkey is persistent, and Russia’s leverage here is diminishing. 

Central Asia could, therefore, become a key battlespace in the long-running rivalry between these two regional competitors in the future.