Money Never Sleeps
The recent currency and bond market drama that unfolded in the UK came as a bit of a surprise, particularly to investors who aren’t used to following currency moves and their typical effects on capital markets. In an effort to demystify that relationship, this serves as part one of a multi-part blog series on currencies, which may or may not come in rapid weekly succession, but will include subsequent installments — I promise.
The title from the sequel to the notorious film, Wall Street, feels fitting for the first of these installments which will center around the U.S. Dollar (USD). Money truly never sleeps. In 2022, the USD has been wide awake and on a rip, up 22% YTD. Although currencies can exhibit bigger swings than traditional safe-haven assets, the USD is typically looked at as the most stable of the bunch.
The thing about volatility is, it counts on the upside too. In stocks, nobody complains about volatility on the upside, it’s the downside volatility that’ll get you. With currencies, it’s not that cut and dry. Big upside moves may be good for our purchasing power abroad (especially now with the USD close to parity with both the British Pound and the Euro for the first time in roughly 37 years), but they can pose headwinds to financial assets, corporations with international revenue, emerging market countries, and our trade balance.
Now, the focus has shifted from trying to call a peak in inflation, to trying to call a peak in the USD. A longer term chart below shows historical peaks in the Dollar and major macro events that occurred along the way. One thing is clear: the recent runup in the USD is an historic rise that will, at some point, mark another notable peak. The unclear piece is whether we just saw that peak on Sept. 28 when the Dollar Index (DXY) hit 114.78 intraday.
It’s All About Bucks, Kid
Despite the strength and velocity of this move, the current one-year % change (+22.2%) ranks only fourth biggest on the list — beat by periods ending in Aug. 1981, Mar. 1985, and Mar. 2015.
Interestingly, the average one-year forward return on stocks and bonds isn’t much different at 11.6% and 8.0%, respectively. But as we know, actual outcomes rarely hit the “average” number, and it’s more telling to look at the consistency of results in the sample.
The one-year forward returns on the S&P 500, following a large one-year rally in the USD, are erratic at best — falling in a range from -19.4% to 72.3%. Basically, anything could happen. But the return pattern in Treasurys is more stable and more interesting, in my opinion. Not only is the range tighter (-3.2% to 24.1%), but the chance of a notably negative move is lower and less frequent.
Some of this is intuitive. If we assume a peak in the USD is driven by rising rates (thus, making our currency more attractive to foreign investors) and/or high inflation, and tightening monetary conditions, when those forces turn the other way post-peak (i.e., rates fall, inflation moderates, monetary conditions loosen) bonds should theoretically do well. But, if it were that easy, stocks would also do well, and the return pattern for the S&P would be just as consistent.
Herein lies the problem — it’s not that easy. And since most investors focus much more on their stock returns than their bond returns, this unpredictability can be excruciatingly frustrating.
We’re All Just One Trade Away From Humility
Just one trade is all it takes to be humbled — although I’d venture a guess that we’ve all been humiliated by markets multiple times already in our lives. Perhaps multiple times this year (I’ll speak for myself on that one). But quitting — and lunch, according to the movie — is for wimps so we push on.
If Sept. 28th was the USD peak, the data and my instinct continues to say that owning Treasurys is at the very least prudent, if not opportunistic. It also tells me that global uncertainty and macro shocks are still a current story, not one of the past. Thus, the range of outcomes in the stock market is likely to remain wide in the near-term, and we have to get crafty about where to source stable returns from. Treasurys are one of those possibilities and Gold may be another — especially in a volatile global currency environment. If the USD starts a persistent downward trend, the Technology and Materials sectors could benefit as they have the largest international revenue exposure at 58% and 55%, respectively.
Although the mighty Greenback isn’t the only force moving markets and interrupting trends, it’s a powerful one right now. Spend wisely.
Want more insights from Liz? The Important Part: Investing With Liz Young, a new podcast from SoFi, takes listeners through today’s top-of-mind themes in investing and breaks them down into digestible and actionable pieces.
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