While the U.S. dollar (USD) has shown some weakness the past two sessions, the overall trend is for further USD strength, as the global growth narrative remains in place and sentiment hasn’t turned negative. Emerging market currencies have done well against non-USD currencies, and equities continue to move higher due to continued progress on vaccine rollouts and solid growth expectations in major economies. To this last point, the International Monetary Fund raised its world gross domestic product forecast to 6%, while also raising its estimate of U.S. and Chinese growth to 6.4% and 8.4%, respectively.
U.S. yields have also moderated their pace of gains, and foreign exchange volatility remains relatively stable despite elevated interest rate volatility. This constructive growth environment means that high-yield and commodity currencies should outperform low-yielders. In the G-10 space, the euro stands out as a particularly vulnerable currency due to slow vaccine progress, potential lockdowns around the Easter holiday and a more challenging domestic growth outlook.
While fundamentals remain positive, there are signs that market conviction isn’t high. Light positioning in emerging markets, elevated cash balances and low foreign ownership of local bonds all indicate investor hesitancy to participate in the current constructive narrative. It is becoming increasingly clear that different countries will emerge from the pandemic at different rates due to variations on vaccine progress and COVID-19 infection levels. This means that the pace of vaccinations remains the key near-term driver, although increases in global vaccine supplies should see differences in vaccine distribution — and thus economic performance — fade over time.
Relatively higher U.S. yields also remain a concern, especially for low-yielding Asian currencies. The risk for U.S. yields remains tilted to the upside due to U.S. fiscal spending outperformance. On this front, the Biden administration recently unveiled its infrastructure plan. The effect of infrastructure spending should be felt more in the medium to long term and should have less of a cyclical boost relative to COVID-19 relief measures due to the components of the infrastructure bill, including the tax hikes needed to finance government spending. Nevertheless, infrastructure spending will bring upward pressure to U.S. growth and U.S. yields.
As always, economic data remains important. Manufacturing activity has rebounded strongly and broadly (upside manufacturing PMI surprises in the U.S., the U.K., Europe and China), but the services recovery has been more uneven. Further, last week’s U.S. jobs report validated expectations for a strong labor market recovery in the sectors hardest hit by the pandemic, and job data should only continue to improve as the economy continues to normalize.
For this week, market focus will be on services PMIs. Expectations remain for global growth drivers to shift from manufacturing to services as COVID-19 restrictions are gradually removed. Thus far, data appears to show this playing out. In the U.S., yesterday’s ISM services printed an all-time high of 63.7. As for China, its services PMIs also rose faster than expected with a 54.3 print. Stay tuned. | |
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