In April, the U.S. dollar posted its best monthly performance since November 2016 against a basket of major currencies, after falling for five straight quarters. The greenback was buoyed by recent economic data from the U.S. that has been relatively stronger than data from the Eurozone and Japan. Despite April’s strength, we view additional dollar weakness as a very real possibility, but the magnitude of additional weakness is likely muted versus the experience over the 15 months. The Fed’s position of being further into an interest rate cycle compared to other major central banks offers the primary rationale for a strengthening dollar. However, U.S. consumer growth tends to widen trade deficits, undermining dollar strength. U.S. tax reform will likely increase domestic fiscal deficits, which tends to lead to a weaker dollar. The rising possibility of other central banks joining the Fed in interest rate “normalization” also restrains any enthusiasm for the dollar. Finally, U.S. domestic political anxiety, particularly around U.S./China trade tensions, may pressure the dollar.
Oil prices rallied in April, amid the prospect of re-imposition of U.S. sanctions on Iran’s oil sales. West Texas Intermediate crude rose 5.6% percent in April to $68.57 a barrel. Increasing global demand and reports of OPEC supply restraints outpaced rising U.S. inventories and record output were likely causes for oil’s rise during the month. Given recent data we raise our expected range of WTI to $65-$75 per barrel in 2018. On the supply side, we expect U.S. production to continue to increase, while OPEC production cuts maintain balance. On the demand side, world oil demand continues to grow, buoyed by improved global growth prospects. Political changes within Saudi Arabia, and possibly Iran, bear monitoring. In our estimation, much of the strength in crude oil over the past fifteen months has been driven by the drop in the dollar as the two have historically been negatively correlated. Currency fluctuations remain a “wild card” for oil prices. With the backdrop of synchronized global growth, we are mindful of the possibility of a breakout above our new expected range.
New U.S. Policies:
In April, U.S. President Donald Trump announced tariffs on roughly $50 billion in imports from China and imposed restrictions related to the theft of intellectual property. In response, China called for dialogue to address trade conflicts and announced it will add tariffs of $50 billion on imports from the U.S. Following China’s announcement, President Trump instructed his advisors to identify tariffs on an additional $100 billion worth of goods. These announcements have not taken effect as there will be a several month period of public comment and consultation. The economic consequences of these specific actions are limited. We believe that the U.S. is using the introduction of tariffs as a negotiating tactic to open deeper trade dialogues with China. In early May, the Trump Administration sent its top economic advisors to Beijing to begin the negotiation process in earnest.
The stated aim of the U.S.’ initial action is to reduce its trade deficit with China. Longer-term U.S. objectives include leveling the competitive playing field in technology-based global industries. Escalating trade tensions between the world’s two largest economies resulted in recent global financial market volatility and a move to a risk-off investing environment, despite robust global economic prospects. Market participants rightly fear a trade war which would increase the price of goods produced, reduce trade, increase inflation, and reduce output. We do not believe a trade war is the desired end game for either country, nor is this our investment base case. We do believe that the U.S. administration is serious about its trade agenda and that a long period of negotiation with China has begun.
State and Municipal Finances:
The underfunding of state and municipal pensions has long been recognized. However, we are now putting this simmering issue on our “radar screen.” These types of issues tend to be “kicked down the road” until suddenly they can no longer be ignored. The tipping point may never materialize, but several recent developments have caught our attention: Puerto Rico’s debt crisis, Illinois’ debt rating flirting with “junk” status, temporary government shutdowns in New Jersey and Maine, severe fiscal problems in Connecticut while its capitol city, Hartford, explores bankruptcy, and new tax law which caps the deduction for state and local taxes at $10,000 through 2025. These developments, while no immediate cause for alarm, are particularly striking given they are coming after a multi-year economic expansion, a time when states and municipalities revenues peak cyclically.
Bitcoin rose 35.3% in April 2018 to end the month at $9,273 per Bitcoin, as the cryptocurrency continued to garner mainstream media and investor attention. Bitcoin is a claim on a private key which provides for a method by which value can be transferred between users. It isn’t an investment in a company, a technology, or a stream of cash flows in any way. We do observe that the price action on Bitcoin in particular does seem to resemble mania experienced in previous technology obsessed markets, similar in character to the “‘tronics” mania in the 60s, and the “dot com” mania in the ‘90s. This is not to say that Bitcoin is worthless, and in fact we believe that there is some intrinsic value to Bitcoin and other cryptocurrencies. Currently, the Fifth Third Private Bank is not facilitating transactions in Bitcoin or other cryptocurrencies.