Market Brief: Consumer Worries Drag Dollar Lower

Financial markets are turning more sceptical on the outlook for the US consumer and corporate sector this morning, forcing the dollar into a renewed retreat. Equity futures are pushing lower in response to weaker-than-expected guidance from consumer-spending bellwether Walmart, and after reports suggesting that new Defense Secretary Pete Hegseth had ordered the Pentagon to cut 8 percent from its budget in each of the next five years hammered military-adjacent stocks. Treasury yields are edging lower, with the ten-year holding just above 4.5 percent, and currencies like the Canadian dollar, Mexican peso, euro, and Japanese yen are advancing amid thin trading flows against the greenback.

Labour market conditions look stable. The number of Americans filing initial applications for unemployment benefits inched higher to 219,000 in the week ended February 15—roughly consistent with pre-pandemic averages—and 1,869,000 continuing claims were submitted for the week ended on the 8th, bringing the four-week moving average down to 1,862,000. Job cuts made by Elon Musk’s ‘Department of Government Efficiency’ may show up in the coming weeks, but haven’t had a visible impact thus far outside Washington DC, with fewer than 25,000 roles believed to have been eliminated.

Minutes taken during the Federal Reserve’s January meeting painted a picture of caution. Policymakers saw the risks to achieving their dual inflation and employment mandate as roughly balanced, but some worried that “potential changes in trade and immigration policy” could “hinder” progress on reducing price pressures. “A majority of participants observed that the current high degree of uncertainty made it appropriate for the committee to take a careful approach in considering additional adjustments to the stance of monetary policy,” the minutes said. “Many participants noted that the committee could hold the policy rate at a restrictive level if the economy remained strong and inflation remained elevated, while several remarked that policy could be eased if labor market conditions deteriorated, economic activity faltered, or inflation returned to 2 percent more quickly than anticipated”.

Markets are positioned for a long stay on the sidelines. The Fed is seen easing slightly more than had been expected in the days running up to Trump’s inauguration, but there are just two rate cuts fully priced in by the end of next year, implying a far less aggressive adjustment than was anticipated when the central bank began moving in September.

The Chinese yuan is trading nearly unchanged after Donald Trump said a new trade deal with Beijing was “possible,” and said he has a “great” relationship with Xi Jinping. As we’ve previously outlined, trade with the United States has become less critical to China over time, with domestic imbalances growing in importance. With the world’s most important property market still declining in year-over-year terms and authorities demonstrating a continued reluctance to stimulate the household side of the economy, consumer sentiment remains near historic lows.

It's difficult to measure precisely, but it is reasonable to assume that capital flight out of China is (again) playing a major role in global asset price movements. A rough proxy for financial flows across Chinese borders suggests that more than a trillion dollars left the country last year—and the scale could be much larger, with many households likely utilising semi-illicit means to stock up on “safe-haven” assets like gold and cryptocurrencies.

A number of readers have asked when asset prices might begin reacting to the changes in the international political order that are now underway. Investors have thus far been relatively untroubled by the longer-term implications that could arise from America’s turn away from free-trade ideals and its newfound friendliness with traditional adversaries, and have instead welcomed the opportunity for lower taxes, increased corporate revenues, and a European ‘peace dividend’ in the immediate future.

But the reality is that markets are terrible at pricing geopolitical risks. Today’s situation (hopefully) isn’t directly comparable, but the classic chart reproduced below—from Barton Bigg’s ‘Wealth, War and Wisdom’—illustrates how the value of the German stock market soared after the Nazis seized power, kept climbing through the long period of massive militarisation that led up to the Second World War, and remained elevated well after Hitler’s disastrous decision to invade Russia. From a practical perspective, political considerations should be avoided in conversations with barbers and bartenders, and largely kept out of investment and hedging decisions.

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