Prices of all three are typically denominated in dollars and hence move inversely to the currency. The upshot is that once investors began factoring in higher US interest rates in summer 2014, each asset class suffered a troublesome 18 months.
Despite the first US hike in seven years finally arriving in December, these assumptions have been reassessed this year amid renewed nervousness over the global economy. That has led to a 3.9 per cent pullback for the dollar year to date, and the unusual sight of emerging markets and commodities outperforming at a time of market unease.
These trends were reinforced last week by cautious comments from Federal Reserve chair Janet Yellen, which prompted traders to further push back their outlook for future rate hikes, sending the greenback lower in the process.
Dominic Rossi, Fidelity International’s global CIO of equities, suggests this move illustrates the change in circumstances.
“I don’t think the post-Fed meeting weakness in the US dollar is the start of any material depreciation trend, but I do think that the period of dollar appreciation we have been witness to over the last few years… is now at an end,” Mr Rossi said.
But the question for many is whether this adjustment proves vicious or virtuous for risk assets.
The main risk involved in further dollar weakness is investors taking it as a sign that US growth is much worse than first thought. Talk of a recession is already a lot more prominent than it was three months ago, though recent data actually shows an improving picture, according to the Citigroup economic surprise index.
That index, which measures whether data releases outperform or underperform economists’ expectations, has now moved back to a point of equilibrium for the first time in several months. It points to what is perhaps a preferred scenario for a number of investors: a return to a ‘Goldilocks’ economy, free from the stresses of either a serious slowdown or higher interest rates.
“The trajectory of the US dollar remains a key consideration to our asset allocation outcome,” says John Bilton, global head of multi-asset strategy at JPMorgan Asset Management.
“If more stable and uniform global growth aids dollar consolidation, that would signal increased risk appetite and a better outlook for emerging markets. But if the dollar falters because of sputtering US growth, the outlook would darken for risk assets generally.
“We remain optimistic about global growth and anticipate a more virtuous end to the dollar cycle, but the risks to this core view reinforce our more cautious allocation stance.”
The finely-balanced view is shared by Schroders’ multi-asset team. They say renewed dollar strength would be “destructive” in terms of global growth, but note that further weakening against major currencies is unlikely to occur at a time of monetary easing elsewhere and a general wariness of stronger exchange rates.
This means the dollar is likely to be “range-bound” until other economies can demonstrate improvements of their own – with gold, therefore, the main beneficiary of any renewed dovishness from the Fed, according to the team.
Richard Turnill, global chief investment strategist at BlackRock, indicates the degree of uncertainty that underlines such forecasts.
“Many BlackRock fund managers have raised EM allocations. Yet we are not all in. Many things could go wrong. The Chinese economy and currency could slip again. US growth could accelerate, forcing the Fed to tighten more quickly than expected and sparking a dollar rally.”
As commodities and emerging markets have rallied, so too have previously favoured sectors slumped this year. The Nasdaq Biotechnology index, for example, is down some 24 per cent year to date. These sudden reversals mean caution is understandable – but many are backing them to continue should the dollar remain subdued.
For Fidelity’s Mr Rossi, however, an end to the latest era of dollar strength will, in fact, mean a return to some familiar dynamics. He sees little scope for a fresh bounce in emerging markets or commodities, given structural pressures continue to exist. Instead, he favours areas hit hardest by the sector shifts that have been a feature of developed equity markets at the beginning of 2016.
“I see leadership reverting to those areas least impaired by recent developments; that is the sectors with high levels of intangible assets and intellectual property, such as information technology and healthcare,” he said.
