Outlook<\/p>\n
It seems clear that most currencies are suffering from a flight to the safe-haven dollar, even the Swiss franc and the Chinese yuan. To be fair, both are prone to intervention, and indeed, Reuters reports \u201cThe Bank of Japan warned of possible intervention to arrest yen weakness, while the Swiss National Bank said it was more willing to intervene to counter the safe-haven franc’s rise. The \u200bresulting fallback in the franc tallied with a curious retreat in gold.\u201d<\/p>\n
We need to worry about that strange jump in the 10-year yield, too. It can mean any or all of several things, including a renewed worry about US inflation arising from last week\u2019s PPI and bolstered by the ISM manufacturing input price jump.<\/p>\n
The CME Fed<\/a> Watch tool shows that the probability of a rate cut in June was 42.8% a week ago and has faded down to 33.8% now. A big 62.4% think rates<\/a> will be the same in June as now, from 50.4% a week ago. Nobody can untangle what is due to war and what is due to inflation expectations.<\/p>\n As for Europe, the first talk about the war\u2019s effect on the economy was overly optimistic. But then the entire continent\u2019s reliance on natural gas came into focus as Iran closed the Strait of Hormuz and bombed oil and gas facilities all over the region, especially in Qatar. Shutting down the Qatari facilities and export capability is a big deal for Europe. Yesterday QatarEnergy has halted production and declared force majeure following drone attacks on its primary facility. See the chart from Reuters. Natural gas prices have already doubled.<\/p>\n And here comes politics again. The rest of the world does not trust Trump, and rightly so. Why would anyone trust the US to continue to supply the world with oil and natgas under Trump? The US is a net exporter of both and in fact, supplied 58% of the EU\u2019s LNG last year. Now Trump says he will do something about fixing the rising prices of oil and gas to Americans, although we await how he thinks he can do that (and everyone knows Trump lies). He isn\u2019t saying anything about helping Europe.<\/p>\n Therefore, to some unknown extent, the rising dollar is due at least in part to energy self-sufficiency and not really the old safe-haven narrative. The weakness in energy-less economies (Japan, SE Asia) can contribute to currency softness. It\u2019s a little odd that energy rich economies like Canada and Australia are not doing better.<\/p>\n Forecast<\/p>\n So, is it all about the oil? Well, maybe more than anyone likes to admit. Since the war is going on for another 4-5 weeks or more, we can\u2019t expect respite in this quarter, and that means the dollar has more room to run. It\u2019s helpful that the re-emergence of US inflation is pushing out the probability of rate cuts, too.<\/p>\n One worry: Trump doesn\u2019t like the stock<\/a> market in retreat. He thinks the S&P is about him. What changes would he make\u2014like accelerating the end of the war\u2014to get the equity indices running up the flagpole again?<\/p>\n Points of view<\/p>\n BoA\/ML has a nearish-term outlook<\/a> (from now to 3 months) that includes these: \u201cU.S. economic uncertainty rises but fiscal and monetary supports keep the U.S.\u2019 economy clear of recession and profit growth intact.<\/p>\n \u201cHigher global oil prices have a larger near-term economic impact on net energy importers like Japan, Europe and China versus energy-independent U.S.<\/p>\n \u201cU.S. dollar shifts from slight weakness to strength. Oil and Gold prices rise (price hikes could be sharp if tanker passageways are shut). Energy sector rallies. Defense industrials rally.\u201d There\u2019s more, but the point is that while the position here is not complacency, panic is not called for, either, at least not yet. Trading opportunities exist<\/p>\n For the 6-18 month path, here\u2019s what to expect:<\/p>\n Equity volatility declines toward normal levels. Equity markets normalize and begin to track corporate profit fundamentals.\u00a0 U.S. dollar resumes a slightly weaker path<\/p>\n Credit stabilizes and begins to outperform Treasurys\u00a0 Higher-quality Equities including shares and solid dividends join the leadership ranks.<\/p>\n Technology and Financial shares stabilize.\u00a0 Utilities and Industrial remain leaders.<\/p>\n