We reflect on the weakest month of 2017 for the US dollar and the continued decline in corporate credit spreads.

Dollar declines

What’s happened?

In July, the US dollar experienced its weakest month of what has been a disappointing 2017, representing the sixth month of declines this year.

Why?

In the six weeks that followed Donald Trump’s election in early November 2016, the value of the US dollar rose almost 5% on hopes of an expansionary fiscal policy from the incoming government and the boost that might give to economic growth. However, Trump’s Presidency has, so far, been beset with difficulties, including accusations of Russian involvement in November’s election, a number of high profile sackings and a struggle to get the Congressional support needed to implement campaign promises, contributing towards the dollar’s decline. July turned out to be worse than the months that preceded it with the greenback falling 2.9% as the government’s latest attempt to repeal Obamacare failed and as the White House communications director was sacked just ten days into the job. Additionally, expectations of further rate increases from the US Federal Reserve this year declined as economic data have broadly deteriorated and inflation has moved further from the Fed’s 2% target.

What to take away from it?

Predicting the direction of a currency can be difficult. At the turn of the year, with Trump promising lower corporate taxes and infrastructure investment, and the US Federal Reserve having just raised interest rates and predicting an additional three hikes in 2017, there were many market participants forecasting further gains for the US dollar. For the various reasons, those predicted gains have not been forthcoming. The difficulty in forecasting currency movements serves to reinforce the importance of diversification, not just by asset class but also by geography. Exposure to a diverse range of companies with share prices listed in different currencies can reduce the foreign exchange risk of a portfolio. Please speak to your Investment Manager for more information.

Credit spreads grind lower

What’s happened?

Investment-grade US dollar, euro and sterling credit spreads have moved lower this month, and are at their lowest levels for more than two years.

Why?

Credit spreads are the additional yield, measured in basis points, that a corporate bond offers in comparison to a government bond of similar maturity, and are an indication of a company’s credit risk. A risky company should have a wider spread on its corporate bonds than a company that is considered safe, all else being equal. In aggregate, they can be considered a measure of broad credit conditions and with generally improving global economic conditions, monetary policy that remains overwhelmingly accommodative and investors still on the lookout for yield, spreads have declined recently.

What to take away from it?

While the scope for further spread tightening is diminishing, a continuation of the current economic and monetary policy environments could yet see corporate spreads fall further, potentially to levels seen before the financial crisis. However, investors should also be aware of factors that could see spreads widen. While spreads have been moving gradually lower since 2009, there have been a few hiccups along the way, in particular during the height of the eurozone crisis when euro spreads rose above their US and UK counterparts and more recently, as sterling spreads widened in response to the result of the UK referendum.