..... And the analysts don’t expect the moves to be short-lived. Rather, they consider early 2014 to be the long-awaited start of a period of dollar outperformance of a kind that historically has lasted anywhere from six to nine years. It took six months for the divergence to get going, so the dollar’s response to interest rate changes is neither automatic nor immediate. Indeed, in seven out of eight recent periods in which interest rates rose – the first in March 1972 and the most recent in June 2004 – the dollar actually lost value in the first year of each multi-year cycle before eventually following the more logical trajectory of strengthening.
Investors were not simply being irrational by shunning dollars just as they are expected to begin appreciating. Consider what it means to “own,” or to be long, the dollar. Most investors seeking a way to profit from changes in exchange rates turn to government bonds, and in the case of the dollar, that means Treasuries. Given the size of the U.S. government’s current account deficit, which is financed with regular auctions of Treasury bills and notes, odds are that these investors already have a significant chunk of Treasury securities in their portfolios. And as rates were rising, they were watching the value of those assets erode. With little clarity on just how far rates could go, the risk of buying too soon was akin to doubling down on an unfavorable investment—and the possibility that the new purchases would soon be declining in value as well. What we witnessed for much of 2013 is the outcome of that thought process in action. As the yield on the 10-year Treasury has risen, foreign owners of these bonds have responded by selling, rather than by buying more.
Markets have for some time been expecting the Federal Reserve to start reducing monthly asset purchases either in December or January, and Credit Suisse forecasts that U.S. Treasury yields are likely to stabilize soon at a new, higher level (around 3 percent on 10-year notes, up from 2.86 percent now). Considering both of those things, history and logic suggest that investors would focus less on their recent capital losses (and the fear of adding to them) and more on the opportunity presented by higher yields. That mindset shift seems now to be under way, if belatedly so. It’s a great reminder that even if two market trends tend to frequent the same parties, they may not always arrive together.
..... And the analysts don’t expect the moves to be short-lived. Rather, they consider early 2014 to be the long-awaited start of a period of dollar outperformance of a kind that historically has lasted anywhere from six to nine years. It took six months for the divergence to get going, so the dollar’s response to interest rate changes is neither automatic nor immediate. Indeed, in seven out of eight recent periods in which interest rates rose – the first in March 1972 and the most recent in June 2004 – the dollar actually lost value in the first year of each multi-year cycle before eventually following the more logical trajectory of strengthening.
ReplyDeleteInvestors were not simply being irrational by shunning dollars just as they are expected to begin appreciating. Consider what it means to “own,” or to be long, the dollar. Most investors seeking a way to profit from changes in exchange rates turn to government bonds, and in the case of the dollar, that means Treasuries. Given the size of the U.S. government’s current account deficit, which is financed with regular auctions of Treasury bills and notes, odds are that these investors already have a significant chunk of Treasury securities in their portfolios. And as rates were rising, they were watching the value of those assets erode. With little clarity on just how far rates could go, the risk of buying too soon was akin to doubling down on an unfavorable investment—and the possibility that the new purchases would soon be declining in value as well. What we witnessed for much of 2013 is the outcome of that thought process in action. As the yield on the 10-year Treasury has risen, foreign owners of these bonds have responded by selling, rather than by buying more.
Markets have for some time been expecting the Federal Reserve to start reducing monthly asset purchases either in December or January, and Credit Suisse forecasts that U.S. Treasury yields are likely to stabilize soon at a new, higher level (around 3 percent on 10-year notes, up from 2.86 percent now). Considering both of those things, history and logic suggest that investors would focus less on their recent capital losses (and the fear of adding to them) and more on the opportunity presented by higher yields. That mindset shift seems now to be under way, if belatedly so. It’s a great reminder that even if two market trends tend to frequent the same parties, they may not always arrive together.