It’s been a tough few years since the financial crisis. But life is getting better in the US, no doubt about it.
America posted a stunning set of employment figures on Friday. In November, more than 320,000 new jobs were created. That absolutely trounced the 230,000 predicted by economists. Previous months’ figures were revised higher too.
I’ll be the first to say that it’s stupid to base your entire investment strategy on one set of volatile figures. But the trend here is clear. Americans are getting jobs fast.
Good news? It certainly is for the man and woman in the street.
But for investors, it could make life very tricky indeed.
Why a recovery in the US could derail financial markets
Since the financial crisis turned around in March 2009, life has been good for investors.
A significant chunk of the population has had to cope with unemployment, low-to-negative savings interest, and frozen wages.
But anyone with the available capital and gumption (or foolhardiness) to invest – and the ability to stay invested – has done very well indeed.
However, that might now be set to turn around. And it boils down to one main thing – the US dollar.
The US currency ended last week at its highest level in eight years. There are good reasons for that. The strong jobs data means the economy is getting stronger. That means that the Federal Reserve will be under pressure to raise interest rates more quickly than investors had expected.
All else being equal, higher interest rates tend to make a country’s currency more attractive. It’s just like a bank account – if one bank offers a higher interest rate than another, then you’re likely to opt for the higher rate, unless there’s an obvious reason not to.
So why might a stronger US dollar make life tricky for investors? In short, it’s because the US dollar is the world’s reserve currency. Almost everyone uses it for something.
So when the US dollar strengthens – ie the US dollar gets more expensive – monetary policy around the world gets tighter, because dollars cost more. And for a market that has been driven higher by cheap money, that’s bad news.
Emerging markets are already being hit by the stronger dollar
Of course, some markets will feel the pain of a tighter dollar much more keenly than others. Emerging markets tend to be the most vulnerable. For a start, a rising US dollar is usually bad news for commodity prices. That makes life tough for resource-dependent economies. (You can read more about this in our current ‘Oil Price Wars’ issue – get your first four issues free here if you’re not already a subscriber).
The Bank for International Settlements (BIS) is often described as the central bankers’ central bank. It warned yesterday of how a strong dollar could expose many emerging markets by making it harder for companies who have borrowed in US dollars to pay their debt.
As the FT points out, many governments in Latin America and Asia have learned painful lessons from currency crises of the past. As a result, they no longer peg their currencies to the dollar. But “companies in emerging markets have been borrowing heavily via the issuance of dollar securities in recent years”.
But it’s not just emerging markets. More generally, tighter monetary policy could reveal areas of underlying weakness that free-flowing credit is currently concealing.
For example, the BIS also highlights a recent ‘melt-up’ in US bond prices that happened on 15 October. It didn’t last long, but only because the central bank intervened.
Can money printing by other countries offset the US tightening? Potentially. But poor old Mario Draghi is clearly having a struggle dragging the Germans over to his side of the table when it comes to quantitative easing. And the Japanese can’t necessarily provide enough stimulus for the entire world themselves.
In the longer run, expect more money printing
So what happens? The risk is that if global liquidity gets too tight, we’ll see asset prices fall and perhaps even another crash, as the dodgiest bits of the market revealed. Or as Warren Buffett puts it: “Only when the tide goes out, do you see who’s been swimming naked”.
Of course, central bankers aren’t likely to take too kindly to another crash. Researchers on global money flows, Crossborder Capital, suggest that as a result, we may end up seeing both the US and China forced into doing more quantitative easing later next year. That would push asset prices higher once again.
In the meantime, we’d suggest sticking with Japan (where money-printing is happening) and Europe (where we’d expect money printing to happen). It’s also worth getting US dollar exposure, as we’ve mentioned many times in recent years – you can find out more about how to do it in this recent MoneyWeek story.
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