Dollar Surge Surprises Analysts

The dollar has been soaring lately and surprising many analysts.

After the latest upward surge, the PowerShares DB US Dollar Bullish ETF (UUP) still is down 4.50% over the last 12 months and 0.85% annualized for the last three years. But it’s up 4.86% for the last three months, 3.39% for the last four weeks and 1.92% for the last week.

That’s a big turnaround from the decline that began at the start of 2016 and continued through early 2018.

What’s causing the dollar’s recovery and what does it mean? A major factor in the dollar’s surge is a change in U.S. economic growth relative to the rest of the world.

While the U.S. growth rate is a bit slower than it was during most of 2017, growth ratcheted down even more in much of the rest of the world.

Earnings reports from some multinational companies are a good indicator of the change in global growth. Companies that break out sales by region are reporting that growth outside the United States has declined much more than in America.

We’re also seeing significant declines in most of the Purchasing Managers Indexes outside the United States. All still are above 50, indicating growth. But in just a few months, they have declined significantly from their recent highs.

The Economic Surprises Indexes (ESI) also show the recent divergence between the United States and Europe. For the United States, the ESI had a modest decline recently. That means a few economic data reports were below expectations. For Europe, however, the ESI is decidedly negative. Recent data consistently have been below expectations.

It is important to note that Europe’s economy still is growing, but at a slower rate. The problem is people generally were very optimistic about Europe last year, and the data haven’t met expectations. People now are recalibrating their expectations. Last year, they were selling U.S. assets to reinvest the proceeds in what they viewed as European investments with superior potential. Now, investors are moving some of that money back to the United States.

Rising U.S. interest rates, a fear of trade wars and concerns about real wars also have caused some investors to seek the safe haven of the dollar.

The rise in the dollar has been very sharp. It hit a bottom in mid-April and just this week closed above its 200-day moving average for the first time since May 12, 2017. That was the dollar’s seventh-longest streak below the 200-day moving average since 1971.

It is too early to tell if this is the end of a dollar bear market or only a short-term bull rally in a bear market.

It isn’t clear whether a strengthening of the dollar will have any effect on stock prices. A strong dollar hurts sales of global companies based in the United States, so that can restrain some stock gains. What about the rest of the market?

The theory is that a strong dollar is bringing investments into the United States, and that should help stock prices. But the theory doesn’t always play out. In fact, the historic record is mixed. Sometimes the S&P 500 rises with the dollar, other times it declines when the dollar is climbing.

A strong dollar does tend to hurt commodity prices, and we’ve seen that play out in the last week. Most of the commodities and commodity exchange-traded funds (ETFs) that have had strong rallies in 2018 lost value in the last week.

International stocks that are priced in dollars for U.S. investors also declined in the last week.

If the dollar rally continues, I’d expect stocks of U.S. companies that primarily have domestic customers to outperform global U.S. companies and international stocks. I’d also expect to see some weakness in commodities. U.S. Treasury bonds also might do well if interest rates don’t rise much.

But I expect the growth divergence between the United States and the rest of the world to shrink. Most of the globe should bounce back from a sluggish first quarter.

The Data

Manufacturers are doing well in the Midwest, according to the latest Kansas City Fed Manufacturing Index. The index rose to 26 from 17. Most of the other regional bank indexes registered declines in the last month. This index can diverge from the others because of a greater reliance on energy and commodities.

The Dallas Fed Manufacturing Survey, which also is heavily influenced by energy, came in at 21.8. That was well above expectations. Also, last month’s initial 21.4 reading was revised higher to 22.8. The Production Index rose more sharply to 25.3 from 14.4.

The Chicago Purchasing Mangers Index rose to 57.6 from 57.4. The prices paid component hit a seven-year high, which was said to be primarily from rising steel prices.

The PMI Manufacturing Index was 56.5 compared to 55.6 last month to mark its highest reading since September 2014. The report also showed stretched capacity, with prices rising at the fastest rate since mid-2011.

The ISM Manufacturing Index declined to 57.3 from 59.3. Signs of stretched capacity in this report were longer delivery times and higher delivery costs. Also, orders rose at a sharp rate. Some respondents indicated that the steel and aluminum tariffs are causing them problems.

Factory Orders were mixed. The headline number increased a strong 1.6% and last month’s number was revised higher to 1.6% from 1.2%. But a large percentage of that was for aircraft orders, as in recent months. Excluding transportation, orders increased only 0.3% in February and 0.2% in January. Business investment in core capital goods declined 0.4% after increasing 1.0% the previous month.

Personal Income was up a modest 0.3%, following the previous month’s 0.4% increase. Consumer Spending increased slightly more at 0.4% compared to the prior month’s 0.2% increase, which was revised down to 0.0%.

The non-manufacturing sector of the economy continues to do well. The PMI Service Index increased to 54.6 from 54.0. There was strong growth in new orders and employment. The ISM Non-Manufacturing Index reached 56.8. That still indicates strong growth but dipped from last month’s 58.8. Survey respondents blamed trade tensions and tariffs for the decline.

But the big news in that report for many people was inflation. The Fed’s preferred inflation gauge, the PCE Price Index, was flat for the month but rose 2.0% for the past 12 months. That’s right at the Fed’s target rate. But the core index, after subtracting food and energy, rose 0.2% for the month and only 1.9% for 12 months. This shouldn’t alarm the Fed, but a number of economists and analysts said it puts pressure on the Fed to increase rates faster.

Consumer Sentiment, as measured by the University of Michigan, rose to 98.8 from 97.8 recorded in the mid-month flash report. The sentiment reading still is below the 14-year high of 101.4 reported in March.

Pending Home Sales, as reported by the National Association of Realtors, rose only 0.4% for the month, compared to 2.8% last month and expectations of 1.0%. Analysts indicate the roadblock to higher sales is a lack of inventory for sale, not a lack of buyer interest.

Wages rose significantly in the first quarter, according to the Employment Cost Index. Overall employer costs rose 0.8% for the quarter and 2.7% over 12 months. The 12-month rate is the highest in 10 years. Wages and salaries increased 0.9% for the quarter and 2.7% for 12 months, while benefits increased at lower rates.

Productivity remains weak. For the first quarter, productivity came in at an annualized rate of 0.7%, while the fourth quarter of 2017 was revised higher to 0.3% from its original 0.0%. Compensation increased 3.4% for the quarter. The combination of higher compensation and lower labor costs means unit labor costs rose 2.7%.

The first estimate of first-quarter gross domestic product (GDP) came in at 2.3%. As we expected, that shows growth slowed a bit from the fourth quarter of 2017, but 2.3% was above expectations. A major growth factor for the quarter was increased business investment, which should boost growth in the future.

Once again, the lead-ins to Friday’s Employment Situation reports are positive. The ADP Employment Report registered 204,000 new private sector jobs for the month. Last month’s 241,000 number was revised down to 228,000.

New unemployment claims rose only 2,000 from last week’s 49-year low. That brings the four-week average to a 45-year low.

The Markets

The S&P 500 lost 0.16% for the week ended with Wednesday’s close. The Dow Jones Industrial Average declined 0.66%. The Russell 2000 returned 0.29%. The All-Country World Index fell 0.10%, while emerging market equities added 0.04%.

Long-term treasuries increased 1.18% for the week. Investment-grade bonds gained 0.09%. Treasury Inflation-Protected Securities (TIPS) returned 0.50%. High-yield bonds rose 0.27%.

The dollar rose 1.92%.

Energy-based commodities were unchanged for the week. Broader-based commodities returned 0.24%, while gold fell 1.26%.

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