If the back half of 2016 was the mirror image of its first half, then 2017 is shaping up to be something in-between. Equity and credit markets continue to grind higher but the composition of the rally has changed. Value and small caps are lagging while growth and yield-generating stocks are back in vogue. Outside of equities, things also look different. Long-dated bond yields have reversed lower, while the U.S. dollar has given up all of its post-election gains. See the chart below.
As the dollar has retreated, both of the traditional major FX alternatives—the euro and the Japanese yen—and less traditional currencies are gaining. Gold is up 12% from its December low and more exotic dollar alternatives are surging. Last week bitcoin hit a high of $2,800, making it twice as expensive as an ounce of gold. Other cryptocurrencies are also surging. This has some investors wondering whether this is the start of a long-term dollar decline. We are skeptical. Instead, we believe something more mundane is happening: a reevaluation of the post-election narrative.
Reversal of the “Trump Trade”
Not all but much of the post-election rally was predicated on a particular narrative: The new administration would provide an economic boost in the form of tax cuts and fiscal stimulus. Given the visible struggles in passing healthcare reform and the ongoing investigations, investors are reevaluating the extent to which the administration can deliver. Tax cuts and stimulus may arrive late, in a smaller package, or not at all. This is causing investors to recalibrate their growth and rate expectations, in turn impacting the dollar.
Declining expectations for U.S. growth
The post-election narrative was not just about Trump. There was also a growing view that the U.S. was finally shaking off its post-crisis malaise. Recent evidence has been mixed. The U.S. Citigroup Economic Surprise Index fell into negative territory earlier this spring. Other indicators, such as the Atlanta Fed GDP Tracker called GDPNow, suggest a robust rebound in the second quarter, but it is not clear the economy is shifting into a higher growth regime. At the same time most measures of inflation are decelerating, not accelerating.
The rest of the world is catching up
After leading for most of the post-crisis period, other parts of the world are starting to stage their own rebounds. Real U.S. GDP was 1.2% in the first quarter; in the eurozone it was 1.7%. While U.S. growth expectations for 2017 have fallen 0.15% since March, expectations for European growth are rising.
None of this is particularly bad news for the United States. Growth is still respectable and a weaker dollar is a de facto monetary easing. The reversal in the dollar has also aided and abetted the rebound in emerging markets, many of which struggled during the post-election dollar rally. It simply means that the U.S. does not look quite so strong, or the rest of the world as weak as some had assumed late last year.