Two Reflections on January

Looking at the weakness of the US dollar and the sharp rise in inflation

 

We reflect on two things that mattered for the markets in January and what it means for investors: the weakness of the US dollar and a sharp rise in inflation.

US Dollar Weakness

What’s happened?

Between May and the end of December 2016, the US dollar index rose 10.4%, adding to strong rallies seen during 2015 and 2014. However, last month saw a reversal of this move, as the greenback fell 2.6% versus a basket of its peers, the third worst monthly performance for the US dollar in almost five years.

Why?

Comments from newly inaugurated President Donald Trump had an impact. Not only did Trump suggest that the US dollar was “too strong”, he also called out other nations, including Japan, China and Germany for making efforts to devalue their currencies in order to gain a competitive edge over their trading partners.

What to take away from it?

It has been customary for US Presidents to favour a ‘strong dollar policy’, so his recent comments could suggest that perhaps Trump may try to break from this tradition. Recently appointed US Treasury Secretary Steven Mnuchin, however, has made more balanced comments stating that he supports a strong dollar over the long-term, but conceded that an “excessively strong dollar may have negative short-term implications on the economy”, in particular by making US exports more expensive to overseas buyers.

Sharp Inflation Rise

What’s happened?

Data released in January showed that inflation, as measured by the consumer prices index (CPI), has risen sharply of late. Eurozone CPI, at 1.8% year-on-year, is at its highest level since February 2013, while UK CPI rose from 1.2% to 1.6%.

Why?

Weak domestic currencies, particularly in the UK following sterling’s sharp depreciation, contribute to inflationary pressures, as companies that have input costs from abroad are faced with rising prices which are then passed onto the consumer. Furthermore, the rally in the price of oil that occurred during 2016 is now beginning to feed through into year-on-year inflation metrics.

What to take away from it?

The rise in inflation has negatively impacted government bonds which have performed poorly over the last six months as inflation expectations have increased. Bonds tend to perform poorly in an inflationary environment. The impact on the equity markets is less clear. Those companies that are able to pass on any price increases to the consumer and generate a higher level of earnings growth are likely beneficiaries of rising inflation, those that are not, may see their share price suffer.