Pounds pounded into submission

Stocks staged an impressive rally yesterday as earnings season came to town with some positive news.  UK finance ministers are in damage control mode which helped yesterday’s markets, despite mixed messaging.

Gilts, guilty. This is America, land of the brave, home of the free… the crossroads of global finance, fueled by the almighty dollar. Sounds good, but it is probably too big to fit on a coffee mug… and probably not completely accurate, at least the last part, the almighty dollar clause, that is. You see the dollar, like most things, is only as strong as the demand for it. Of course, we all want more dollars in our pockets, but I am referring to the dollar as a currency demanded by foreign investors. The US economy is strong, even when faltering, compared to most other nations’, which is why the US dollar and dollar-denominated Treasuries are the safe harbor of choice when things are going sideways elsewhere. In case you haven’t noticed, there has been a bit of economic turbulence about the globe lately. What’s more, yields on US Treasury notes are at rather appealing levels as of recent. They are even more appealing when you consider their relative risk and relative yield. That makes them more attractive to investors in foreign countries where monetary policy may be… er, spongy, for a lack of a better term. Sorry UK, I am referring to you here.

The United Kingdom is very much a part of that tony group The G7, or Group of Seven. The club includes the UK, as you now know if you didn’t, the US, Japan, Germany, Italy, France, and Canada. While the group’s goals are not explicitly economics, one has to marvel at the collective economic might of the members, each one in its own right. The UK has been having a tough go at things ever since Brexit, the pandemic, and the post-pandemic inflation surge. Making matters more challenging is the country’s recent political leadership transition. Now, that is not to say that the UK economy itself is not stable, but compared to its trade partners, we could accurately say, that it is somewhat shaky, relatively speaking. Yes, this period will pass with time, helped along with a bit of policy tweaking, but for the moment, the timing of all that is a bit unclear. Because of that lack of lucidity, global investors, seeking more clarity, have decided to sell UK Government Bonds, AKA Gilts, and purchase US Treasuries. Heavy selling in Gilts causes the bonds to fall in value. When those bonds fall decisively, it could trigger margin calls for big holders like pension funds and insurance companies… which, in fact, it did. That only served to increase the pressure on Gilts. When proceeds of the sales go into US Treasuries, British Pounds must be sold, and US Dollars purchased. That weakens the Pound Sterling and strengthens the Dollar. All of this, on its own, would cause some challenges for policy makers in the UK. Now imagine a new administration advancing a questionable economic policy which included a massive fiscal stimulus package without any clear plan of how to pay for it. That would have to be financed by… um, selling more Gilts… which would cause further declines in the sovereign bonds. Well, that happened. Then it didn’t, and someone got fired for suggesting it. At the same time, the Bank of England was forced to intervene in the Gilt market and purchase bonds in the open market to stabilize it in order to abate the margin selling pressure on public pension funds. The BOE then announced that it would stop the buying and resume its prior selling program. Then it decided to extend the buying… wait, that might have just been a rumor, so the selling may begin again soon. It sounds like a bit of a mess, and it is.

If you think that you are immune to that messy situation with your US stocks and bonds, you aren’t. In fact, much of the up and down volatility we have seen in US capital markets over the past few weeks has been accentuated by all that turmoil abroad, and that connection is the US dollar. Around 1/2 of S&P 500 revenues come from abroad, and a strong dollar is a drag on those. Remember, a strong dollar makes US goods more expensive to foreign buyers, ultimately causing sales to suffer. What’s more, foreign currency denominated profits must be either repatriated into dollars or reported in US dollars. A strong buck makes those profits less valuable. So, a strong dollar, though it sounds good on the tongue, is actually bad for your portfolio. In addition to all of things we are wishing for in the US with inflation, the Fed, interest rates, strong earnings, etc., we must now add to well wishes to UK policy makers.

YESTERDAY’S MARKETS

Stocks rallied yesterday driven by a weaker dollar as UK policy makers reversed a cavalier stimulus plan – see above .  The S&P500 rose by +2.65%, the Dow Jones Industrial Average climbed by +1.86, the Nasdaq Composite Index jumped by +3.43%, and Russell 2000 Index advanced by +3.17%. Bonds gained and 10-year Treasury Note yields broke even at 4.01%. Cryptos gained by +2.11% and Bitcoin added +1.02%.

NEXT UP

• Industrial Production (Sept) may have ticked up by +0.1% after slipping by -0.2% in the prior month.
• NAHB Housing Market Index (Sept) is expected to have declined to 43 from 46.
• Today’ Fed speakers: Bostic and Kashkari.
• Today’s earnings: Signature Bank, Truist, J&J, Hasbro, Albertsons, Lockheed Martin, Goldman Sachs, and State Street, before the opening bell. Netflix, First Horizon, Intuitive Surgical, United Airlines, and JB Hunt are expected to announce after the closing bell.