Topic Tags: Currency

The Great Currency Reversal

As a result of policy uncertainty, shifting sentiment, and a potential U.S. economic slowdown, the dollar has moved lower in 2025, amplifying non-U.S. equity returns for domestic investors this year. This week’s chart outlines this dynamic, highlighting the “return differential” between dollar-based and local currency returns for both developed and emerging market indices. The 8.2% differential for the MSCI EAFE Index, which tracks international developed markets, reflects stronger European currencies (e.g., the euro) that have been fueled by positive growth forecasts and increased defense spending (as noted in “Europe on Defense”). These factors have turned modest equity gains in local terms into significant returns for dollar-based investors. Similarly, Japan has seen a stronger yen in recent months. The MSCI Emerging Markets Index has seen a smaller differential than its developed counterpart this year, but U.S. investors have still benefited from currency effects across several emerging countries. The Brazilian real, for instance, has strengthened in 2025 thanks to a 50 basis point rate hike by the nation’s central bank earlier this month, which has attracted increased capital flows. Taiwan has also seen strengthening of its currency in recent days.

While a weaker U.S. dollar has served as a tailwind for domestic investors in non-U.S. equities, risks related to this trend should be noted. For instance, a weaker U.S. dollar can lead to higher import prices, which can exacerbate inflation and reduce the purchasing power of consumers. A weaker greenback can also discourage foreign investment and serve as a signal of a challenged economic environment. Given the current climate and the currency trends detailed above, it is critical that investors remain diversified across both U.S. and non-U.S. markets to reduce exposure to currency-specific risks and enhance portfolio stability amid global economic fluctuations.

What’s Your Haven? | Who is the “Godfather” of the Bond Market?

No, you are not seeing double. This very special edition of our chart of the week series comes with an added bonus chart with the goal of highlighting key dynamics within fixed income markets that have been top of mind for investors in recent weeks. Read on and enjoy two charts for the price of one!

 

What’s Your Haven?

Fixed income has historically provided three benefits to investors: Income, diversification, and liquidity. U.S. Treasuries are a pure form of diversification given their limited risk with the 10-year Treasury serving as a bellwether, and these securities are viewed by many as safe havens during periods of market stress. Historically, Treasuries and equities have tended to exhibit low to negative correlations. However, much like returns and volatility, correlations are time-varying. For instance, the historical relationship between stocks and bonds broke down in the aftermath of the COVID-19 crisis, when accommodative monetary policy led to higher levels of inflation and the two asset classes moved in tandem. The same pattern took hold over the last few weeks amidst tariff-induced market volatility, with correlations between stocks and Treasuries increasing and hampering traditional diversification benefits. With Treasury rates recently trading like risk assets, there are other safe haven assets to which investors have turned for insulation against volatility.

Gold is often referred to as a safe haven asset given its status as a precious metal that is viewed as a store of value and a hedge against inflation. Over the last few years, gold has offered favorable diversification relative to risk assets with inflation running hot. It also tends to do well when fears are high. To that point, with the S&P 500 Index down more than 8% on a year-to-date basis, spot gold prices have risen from $2,625/oz to $3,312/oz.¹ All of this being said, gold is not necessarily a good investment as it does not provide cash flows and its price movements are largely driven by speculation. Additionally, the correlation of gold to equities fluctuates over time from somewhat positive to somewhat negative, with material variations over longer investment horizons.

Some currencies are also viewed as safe haven assets, with the classic example being the yen given Japan’s stable political system and ample liquidity. The yen has rallied with stocks down this year, moving from ¥157.20/$ to ¥142.66/$. Diversification benefits from the yen have historically been better than those provided by gold, but they have also waned somewhat in recent years. Currencies also suffer from some of the same issues as gold, including a lack of cash flows and price speculation. As such, most currencies are generally best used as tactical hedges as opposed to long-term portfolio constituents.

Diversification is a critical component of portfolio construction and while Treasuries have historically served as safe havens during market volatility, other assets have offered more compelling diversification benefits in recent weeks. However, the viability of these assets (i.e., gold and currencies) as outright replacements for Treasuries in portfolios is questionable given the points made above.

¹ Bloomberg as of April 16, 2025

 

Who is the “Godfather” of the Bond Market?

Current global trade tensions beg the question: Can foreign holders of U.S. debt manipulate the Treasury market? Indeed, some have speculated that China sold Treasuries to put upward pressure on yields last week to retaliate against the U.S. for its new tariffs (i.e., causing the U.S. to borrow at higher rates). This action, however, would likely be painful for China as well. If news of significant Treasury sales by China were to circulate, yields would likely spike, and the value of its remaining holdings would fall. The U.S. also has tools to combat such a move, including quantitative easing (i.e., bond purchases) designed to return yields to normal levels. Ultimately, a retaliatory Treasury sale would be a huge risk to China, not to mention the fact that China’s holdings tend to be of a shorter nature and recent pressure has mostly been on the long end of the curve (which sold off by around 50 basis points last week). Might another country be responsible for this movement?

While some Japanese politicians have lobbied for using its country’s Treasury holdings as a tool in trade negotiations, the ruling party has repeatedly emphasized that Japan should not sell its Treasuries to rile the United States. So, while Japan has indeed been a notable seller of U.S. Treasuries in recent weeks, these sales have likely been influenced by other factors. For instance, Japanese life insurers are major holders of long-dated U.S. Treasuries, and these entities could be rotating out of Treasuries given a cautious stance on U.S. policy. Another potential reason for recent sales is Japanese pension plans rotating into European bonds.

In summary, technical signals from non-U.S. investors can certainly influence the Treasury market, but it is unlikely that these players could engage in outright market manipulation. At the end of the day, the Federal Reserve can pull strings to combat Treasury-related turmoil and remains the godfather of the bond market.

A Cross Pacific Current

The pullback in global equity indices at the beginning of August left many investors racing to understand what had caused such outsized volatility. Amid this market turbulence, there were two seemingly unrelated economic events that occurred on different sides of the globe. On July 31, the Bank of Japan surprisingly announced that it would raise its benchmark interest rate from 0.10% to 0.25%, continuing its transition from the ultra-low rates that had been commonplace in recent time. Later that week, the July U.S. nonfarm payroll employment data, which many use to gauge the health of the domestic labor market, came in below estimates. This report led investors to question the strength of the U.S. economy and whether the Federal Reserve had waited too long to cut its policy rate. Simply put, equity markets reacted negatively. The Nasdaq, which is a growth-oriented U.S. large-cap stock index, exhibited a particularly sharp drop during this time, falling by roughly 7% in less than one week. The speed and severity of this sell-off left many asking if one poor labor report alone was solely to blame. As it turned out, the Bank of Japan’s interest rate decision earlier in the week may have been just as important as it relates to what had occurred in U.S. markets.

A “carry trade” is a strategy wherein an investor borrows in a low-yielding currency (in this case the Japanese yen) and invests the borrowed funds in a higher-yielding asset. While it is difficult to assess the size and scope of these trades, certain statistical relationships can emerge that may shine light on how borrowed funds are being invested. To that point, the chart above shows the year-to-date changes in level of the Nasdaq index and the value of the U.S. dollar (USD) relative to the Japanese yen (JPY). Interestingly, on a rolling 30-day basis since the start of the year, the movements of the NASDAQ and USD/JPY have been moderately correlated with a coefficient of 0.46 (a coefficient of 1 would indicate a perfectly positively correlated relationship). While indeed moderate, this relationship does indicate that as the dollar has weakened relative to the yen, the Nasdaq has weakened in a similar fashion. What might be driving this relationship?

While we cannot draw definitive conclusions based on correlation alone, the carry trade strategy may be partially responsible for the emergence of this relationship. In the first half of this year, U.S. large-cap stocks notched strong performance while the dollar steadily strengthened against the yen, which kept yen borrowing costs low. That said, when the Bank of Japan raised its policy rate (and the cost of borrowing yen) in late July, many carry trade investors were forced to sell assets to pay back the funds borrowed in yen, which was now rapidly appreciating against the dollar.  For those who had been investing borrowed funds in U.S. stocks, harvesting gains from these positions would be a logical move in order to post collateral. It is important to point out, however, that this process can snowball. Specifically, higher demand for yen drives up the value of the currency, which prompts collateral calls for more investors who have borrowed in yen, which leads to further selling of risk assets like U.S. stocks. This feedback loop can be observed in the shaded region of this week’s chart, during which the correlation coefficient between Nasdaq and USD/JPY jumped to more than 0.9.

While this chart highlights one relationship to provide insight into the recent spike in equity volatility, a broader conclusion readers should draw is that changing dynamics within global markets and the opaque nature of certain trades can make risks faced by investors difficult to identify and measure. As a result, it is important for investors to maintain well-diversified portfolios that can weather various market environments.

The Emergence of Argentinian Equities

Argentina has faced myriad economic headwinds in recent time, including hyperinflation, currency-related difficulties, and a series of defaults on its sovereign debt. As the country headed into a presidential election year in 2023, Javier Milei, a member of the Argentinian Libertarian Party, emerged as a front-runner in the race, as many viewed his laissez-faire approach to economic policy as having the potential to correct the nation’s trajectory. Milei ultimately won the presidential election and assumed office in December of last year.

Over the last several months, President Milei has enacted a series of unique and controversial economic policies aimed at making the nation’s currency more competitive, reigning in excessive inflation, and stabilizing Argentina’s economic footing. These policies include the devaluation of the Argentinian peso by more than 50% and the introduction of a crawling peg, which is designed to further depreciate the peso. Additional initiatives by the Milei government include lifting capital controls, slashing state subsidies, and scrapping hundreds of government jobs and regulations. This austerity program, while certainly creating its own set of complications for the Argentinian people, has been largely well received by investors. To that point, the MSCI Argentina Index has returned close to 200% on a cumulative basis over the last two years, which is far in excess of the cumulative returns of both the MSCI Emerging Markets and MSCI Frontier Emerging Markets indices in that time. This performance is a sign of investor optimism related to the country’s economic prospects under Milei’s leadership, and Argentina’s status as a world leader in lithium and copper reserves could provide additional support from market participants. Marquette will continue to monitor the progress made by Argentina on the economic front.

Mind the Gap

Any ride on the London Tube reminds riders to mind the gap: Beware the space between train car and platform as you board and depart the train. A recent trip to London brought this phrase back to me and it seemed like a perfect description of how to look at financial markets this year, with the “gap” serving as the difference between expectations and reality, most particularly in terms of interest rate cuts.

In our market preview, we identified the Fed pivot as a primary driver of financial markets this year, most especially how expectations of cuts would line up with actual Fed policy. Going into the year, the market had priced in at least five cuts, which helped fuel a furious fourth quarter rally and investor optimism for 2024. One quarter in, however, those expectations have been turned on their head. Hotter than expected inflation and jobs reports in March have created a “higher for longer” narrative with the market expecting no more than two cuts during the second half of the year. Some economists have taken an even more bearish stance, suggesting there will not be any cuts. Overall, rates rose across the curve during the quarter as current U.S. debt levels sustained the long end of the curve while the short end was relatively unmoved.

Intuitively, many investors would expect such a big change in rate expectations to weigh heavily on markets, both equities and bonds. In that sense, equity performance was surprising during the first quarter, as the upward trend from 2023 continued. Predictably, bonds suffered as rates rose, but below investment grade sectors were profitable. To be fair, though, it should be noted that equities have endured a difficult start to this month, down 4.6% through April 22 as the higher for longer narrative has gained momentum.¹

Going forward, what should we watch for from asset classes as we venture into a market environment that looks much different than what we were expecting only three months ago?

Japan: This Year’s Vacation Recommendation

Foreign investment isn’t the only thing streaming into Japan. In 2023, the number of travelers to the country surpassed long-term average levels, though that figure still sat below pre-pandemic highs. That said, last year was a clear sign of recovery for Japan’s beleaguered tourism industry, and this trend has continued into 2024. Through the first two months of this year, the number of visitors to Japan is already close to 22% of last year’s total, with tourists coming from surrounding Asian countries and the Western world as well. To that point, nearly 150,000 U.S. citizens visited Japan in the month of February alone. A major driver of Japan’s appeal to tourists is the weak yen. In April, the yen hit a low not seen in over 30 years relative to the dollar, thanks in part to disparity between the policies of the Federal Reserve and the Bank of Japan. These dynamics have allowed U.S. travelers to enjoy more “bang for their buck.”

Earlier this year, Japan slightly curtailed its long-running accommodative monetary policy with the goal of addressing the country’s chronic deflation problem and spurring economic growth. The influx of tourists described above might also provide these desired effects, with several industries, including transportation, restaurants, entertainment, and hospitality potentially standing to benefit. For instance, there has been a material increase in average daily hotel rates in Japan, which recently hit highs not seen since the late 1990s. Although this is just one example of travelers having an impact on Japanese price levels and growth, it is illustrative of what could happen more broadly to industries directly tied to tourism. While the outlook for economic growth and future tourism in Japan is uncertain, it is encouraging to see certain data reflect the pre-pandemic environment.

3Q 2023 Market Insights Video

This video is a recording of a live webinar held on October 26 by Marquette’s research team, featuring in-depth analysis of the third quarter and themes we’ll be monitoring for the remainder of the year.

Our Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real estate, infrastructure, private equity, and private credit, with presentations by our research analysts and directors.

Sign up for research alerts to be invited to future webinars and notified when we publish new videos. 
For more information, questions, or feedback, please send us an email.

Portfolio Trick or Treat

Coming into 2023, investors were cautiously optimistic about 2023 market returns; cautious considering the broad losses across asset classes during 2022 but optimistic about more attractive valuations and the inherent upside potential stemming from these price points. Nine months into the year, which of these opportunities have been “treats” for investors, and which have been “tricks”?

In this edition:

  • The biggest trick of them all: Investment grade fixed income
  • But not all of fixed income has been a trick…
  • Tricks come in all sizes: U.S. small-cap equities
  • Trick, treat, or both? U.S. growth stocks
  • Currency movements still tricky
  • More treat than trick: Emerging markets
  • If you’re not surprised, it’s not a trick: Commercial real estate

Fitch Downgrades U.S. Credit

Fitch Ratings unexpectedly downgraded the U.S. government’s credit rating one notch from AAA to AA+ on August 1, 2023. This is only the second downgrade in history, after S&P Global Ratings, then Standard & Poor’s, made the same adjustment shortly after the 2011 debt ceiling crisis; S&P has maintained the AA+ rating since. Moody’s — the third major U.S. rating agency — still has the U.S. at its highest Aaa rating. Fitch noted the downgrade reflects expected fiscal deterioration over the next three years, the country’s high and growing debt burden, and an erosion in governance over the last several years, marked by bipartisan standoffs and last-minute resolutions. The downgrade and timing have drawn criticism from the Biden administration and economists, citing economic strength and the minuscule risk of the U.S. actually missing any debt payments.

While in practice the downgrade will likely have minimal impact, with the U.S. government broadly considered one of the safest borrowers, markets are reacting. Treasuries initially rallied on the news, anticipating the same flight to quality seen in 2011, though that sentiment reversed this morning, with yields at one point breaching a key resistance level of 4.1% — a level last seen in November 2022. Also likely contributing to the move today is the Treasury Department’s announced plans to sell a higher-than-expected amount of longer-dated securities next week, as it works to replenish the Treasury General Account (reference Marquette’s recent newsletter for additional context). The U.S. dollar initially dipped on the news but has since rallied and is up on the day amid higher yields. U.S. equities, after a steep run, are down modestly today, with growth equities leading the group lower.

Print PDF > Fitch Downgrades U.S. Credit

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Halftime Adjustments

For anyone who regularly reads these letters, recall the market preview edition opined on the outlook for asset classes in 2023, particularly the likelihood of each delivering positive returns for the upcoming year. Given that we are halfway through the year, we would like to use this letter to make “halftime adjustments” to our outlook; with NFL training camps set to open later this month, we couldn’t resist the urge to borrow a football term. We hope this is a quick beach read as you enjoy your summer vacations and prepare for the second half of the year.

This edition re-assesses the outlook for fixed income, equities, and real estate for the second half of 2023.

Read > Halftime Adjustments

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.