GERMAN AND UK BOND YIELDS ARE JUMPING -- THAT'S BOOSTING FOREIGN CURRENCIES AND WEAKENING THE DOLLAR -- DOLLAR WEAKNESS SUPPORTS ROTATION INTO FOREIGN STOCKS -- RISING CANADIAN DOLLAR FAVORS CANADA ISHARES
TODAY IT'S THE BRITS TURNING HAWKISH... Yesterday it was hawkish comments from Mario Draghi that pushed eurozone bond yields sharply higher, and the rest of the world with them. Today it's hawkish comments by Mark Carney that the Brits may have to raise rates soon. Rising bond yields in Europe (and elsewhere) are boosting Treasury yields in the states. Chart 1 shows the 10-Year German Bund Yield surging 12 basis points yesterday on the back of Mr. Draghi's claim that "reflation" is now a bigger threat than "deflation". That change of heart took markets by surprise. As a result, eurozone bond yields jumped sharply and bond prices fell around the world. Mr. Carney added to that hawkish tone today which is pushing British yields sharply higher. Chart 2 shows the 10-Year UK Gilt Yield surging 10 basis points today. Yields are also rising elsewhere. Australia's bond yield is climbing 10 bps. Canada's bond yield is up 8 bps. Hawkish comments have also been coming from Canada. Up to now, the Fed was the only central bank in a tightening mood. Central bankers around the world, however, are at least talking about moving in that direction. Low foreign yields have acted as a weight on higher-yielding Treasury bonds. Rising foreign yields are already helping to boost Treasury yields. That's potentially bad news for bondholders since bond prices fall when yields rise. That's good news for holders of bank shares which are rising again today. But it's bad for the dollar.
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Chart 1
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Chart 2
DOLLAR FALLS TO NEW LOW FOR THE YEAR... The fact that foreign yields are rising is also taking a toll on the dollar. Chart 3 shows the PowerShares Dollar Index ETF (UUP) falling today to the lowest level since last October. The UUP peaked last December and has lost -6% since then. A lot of that loss came from 8% gain in the Euro which has the biggest weight in the UUP (57%). But the dollar has also lost ground against the other five currencies in the UUP. The British pound has gained nearly 5%, the Japanese yen 4%, and the Canadian dollar 2.3%. The Swiss franc and Swedish krona have even bigger gains of 6% and 5% respectively. Emerging market currencies have gained more than 6% against the greenback since the start of the year. That shift away from the dollar into foreign currencies mirrors the shift into foreign assets in general. Previous messages have pointed out that foreign stocks have done better than the U.S. this year. Foreign stocks have gained nearly twice as much as the U.S. this year (15% versus 8%). Emerging markets are the global leaders with a 2017 gain of 19%. When investors buy foreign stocks, they have to buy the local currencies first. And when they rotate out of U.S. stocks, they sell the dollar.
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Chart 3
A WEAK DOLLAR FAVORS FOREIGN SHARES ... The next two charts demonstrate how dollar direction effects the relative performance of global stocks. The blue line in Chart 4 is a ratio of the MSCI World (ex USA) Index divided by the S&P 500. The green area shows the trend of the U.S. Dollar Index. It's clear that they trend in opposite directions. From 2002 through 2007, a falling dollar contributed by stronger foreign stocks (a rising blue ratio). A 2008 dollar bottom caused that relationship to shift in favor of the U.S. A rising dollar from 2008 to the end of 2016 coincided with stronger U.S. performance (a falling ratio). The trend has shifted away the U.S. during 2017. Chart 5 shows a rising dollar in 2016 favoring U.S. stocks over foreign stocks (falling ratio). But dollar peaks in December, March, and April tipped the scales in favor of foreign markets (a rising ratio).
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Chart 4
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Chart 5
THE EURO AND STERLING ARE RISING... The Euro has been the strongest currency in the developed world this year. Chart 6 shows it bottoming last December (as the dollar peaked) and rising to the highest level in nearly a year. It got a pop this week on the jump in eurozone yields. Chart 7 shows British pound getting a nice bump up today on the jump in British yields. Their 50-day averages have exceeded their 200-day lines which confirms their bullish trend. The two rising currencies are giving an added boost to their respective stock ETFs that are quoted in U.S. dollars.
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Chart 6
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Chart 7
STRONG LOONIE BOOSTS CANADA ISHARES... A strong Canadian Dollar is also giving an added boost to Canada iShares. The red bars in Chart 8 show Canada iShares (EWC) surging more than 1% to the highest level since April. That's on the back of rising Canadian bond yields and hawkish talk north of the border. The solid green line is a "ratio" of the EWC divided by the Toronto Stock Index (TSX). The rising ratio over the last two months shows the EWC rising faster than the TSX. That's because of the rising Canadian Dollar (top box) over the same time span. A rising local currency favors a local stock ETF that's quoted in a weaker U.S. dollar. In other words, a rising local currency will cause the local stock ETF to rise faster than its local stock benchmark. I suspect that's happening in a lot of foreign markets. That's especially good for American investors. [Prospects for higher rates in Canada are trumping the negative impact of falling energy prices on the loonie].
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Chart 8
FINANCIALS ARE MARKET LEADERS... Financial stocks are the biggest beneficiaries of rising bond yields. And they're today's strongest sector for the second day in a row. Chart 9 shows the Financial Sector SPDR (XLF) nearing a new three month high. The XLF/SPX ratio (solid line) has already reached the highest level since March. [Financial shares in Europe and Canada are also strong].
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Chart 9
POWERSHARES QQQ HOLDS 50-DAY LINE... Stocks in the U.S. are rebounding today. Part of that may be tied to the fact that technology stocks are stabilizing. Chart 10 shows the PowerShares Nasdaq 100 QQQ finding support at its 50-day average. Major stock indexes are having a good day. Standout performances are coming from banks, small caps, and transports. All sectors (except for utilities) are in the black. It appears that some of the money coming out of falling bond prices is finding its way back into stocks. Interestingly, basic materials and energy stocks are also bouncing with their respective commodities. It could be that the falling dollar is starting to have a positive impact on beaten-down commodity prices. It may also be that optimistic economic talk coming from global central bankers is inspiring more confidence in riskier assets.
