A resurgent dollar is remaking the investment landscape as
Federal Reserve stimulus ends, in a shift many fund managers expect will propel
U.S. stocks to fresh gains and keep bonds buoyant. The Fed in October is
expected to conclude the bond purchases that are widely credited with helping
fuel the run to records for the Dow Jones Industrial Average.
Some investors see the central-bank divergence behind a
virtuous circle taking shape for U.S. markets and the economy, echoing the
powerful U.S. expansions of the early 1980s and 1990s. The prospect of
broad-based gains is shoving aside concerns some investors and analysts have
held about the strength of the U.S. recovery and the high valuations for many
companies' stocks, relative to their earnings.
As growing output and employment enable the Fed to gradually
lift short-term rates, the dollar is likely to continue appreciating against
the yen and euro, investors say. Many investors expect dollar strength to be a
key part of the playbook for coming months and years. The dollar rose more than
8% against the euro and the yen in the third quarter, which ended Tuesday.
An appreciating dollar could make U.S. stocks and bonds more
attractive to overseas investors, who would pocket currency-translation gains.
If inflation remains tame, as many investors expect, Treasury yields are likely
to remain low and the prices of commodities such as fuel and metals are likely
to fall, bolstering consumer spending, economic growth and many asset prices.
The WSJ Dollar Index is up 8.6% from its recent low last
October and finished the quarter at a four-year high. That includes U.S.
consumer-focused companies, such as retailers, or airlines that can benefit
from lower crude prices.
One possible side effect of the potential Fed move: As the
quarter drew to a close, stock and bond markets saw stepped-up price swings.
That is something that will become more common as an eventual rate increase by
the Fed draws closer, raising investor anxiety about the effects of the policy
shift. Such swings would be a sharp change from the mostly placid markets of
2013 and 2014.
To be sure, not everyone is buying the idea that a stronger
dollar will provide a tailwind to U.S. shares and bonds. Brian Singer, a
portfolio manager on the $863 million William Blair Macro Allocation fund,
thinks any impact from divergent paths will be small outside the currency
markets. In part, he says, that's because U.S. stocks "are a little bit
overvalued."
Some gains from dollar strength will come with corresponding
weaknesses. At Thornburg Investment Management, which manages $88 billion,
Chief Investment Officer Brian McMahon said a stronger dollar would be a
headwind for U.S. multinational firms selling goods overseas, because it would
make their products more expensive.
For now, there are few signs price rises are taking hold, in
part because unemployment remains high and wage growth soft. The Fed's
preferred indicator for inflation, the price index for personal consumption
expenditures, was up 1.5% in August from a year ago, below the Fed's target
inflation rate of 2%.
The dollar could take a breather after its recent rally before
eventually rising as much as 20% against the euro and the yen as the Fed begins
tightening policy.
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