You wouldn’t know it from the constant barrage of news on the political and international fronts, but there are positive developments in the background for the financial markets. To be sure, there has been good news with a “Phase 1” tentative trade deal with the U.S. and China, and maybe, just maybe, some Brexit agreement (although it ain’t over until Parliament votes this weekend).
But there is a more positive monetary backdrop developing from lower short-term interest rates and a weaker dollar. And that would be bullish for most risk assets, including U.S. stocks, emerging market debt and equities, and commodities—notably precious metals.
The federal-funds futures market is putting an 89.3% probability of the Federal Open Market Committee voting for a one-quarter percentage-point reduction in its key policy interest rate on Oct. 30, according to the CME Group ’s FedWatch. While a number of economists have pushed back on the notion of another rate cut this month, and most Fed officials remain noncommittal, if not opposed, to further easing, the central bank has a long history of not disappointing market expectations. While the betting line can change by game time, the odds now favor a rate reduction at the next policy confab.
The Fed also has begun buying $60 billion a month of Treasury bills, which it contends doesn’t constitute a policy move like past quantitative-easing, or QE, purchases. (See this week’s Economy column.) In actuality, the buying reverses the quantitative tightening, or QT, that occurred as the Fed reduced its assets, while on the other side of the balance sheet, liabilities, notably currency, increased, resulting in an even sharper shrinkage in bank reserves.
Quantitative tightening was supposed to be like “paint drying,” as former Fed Chair Janet Yellen described it, but resulted in the equivalent of 7.5 percentage points of tightening, nearly three times as much as the actual rate hikes, Julian Brigden, chief economist at MI2 Partners, has estimated. QT has kept the dollar stronger than fundamentals would have predicted, he writes in a client note.
A weaker greenback would provide the missing “cornerstone of a reflationary move,” along with lower rates and higher equity prices. Global investors have been piling into U.S. growth stocks, taking advantage of strong currency and equity returns. As the dollar turns, Brigden looks for a rotation from growth to value stocks, which showed signs of starting in early September.
A weaker dollar and negative interest rates also have boosted hedge funds’ interest in gold, according to Société Générale. The so-called barbarous relic, and exchange-traded funds that track it, such as the SPDR Gold Shares (ticker: GLD), have moved mostly sideways around the $1,500-an-ounce level since late August.
But the bank’s strategists recommend a maximum bullish allocation to gold (5% in its portfolios) because the metal “is increasingly seen as an alternative to cash.” They’re especially bullish on gold since they also expect further Fed rate cuts and a lower dollar. While the bank isn’t advocating a return to a gold standard, it notes that central banks such as the People’s Bank of China are diversifying into the metal.
President Donald Trump has made no secret of his desire for a weaker dollar, which would be consistent with his barrage of tweets calling on the Fed to slash rates. An end to the tariff wars would further ease the upward pressure on the dollar. And that would benefit corporate earnings, as 40% of sales of S&P 500 companies originate abroad. So there’s good reason to bet your bottom dollar that the greenback is close to a top.