Webcast Replay – Navigating Macro Divergences: The Devil Is In The Dollar

The global macro divergences driving the dollar up highlight economic weakness outside the US that may be structural, not just the fact that the U.S. is leading the rest of the developed world’s recovery from the global financial crisis on a cyclical basis. If structural in nature, the need for easier monetary policy globally may last for years, in which case the dollar’s recent strength will be sticky, and the headwinds that poses to growth will linger. To the extent that the global growth outlook remains uncertain, a stronger U.S. dollar constrains the Fed’s ability to raise interest rates.

The Fed trapped itself in a policy feedback loop at the September meeting when the FOMC postponed the first rate hike and ostensibly linking future policy decisions to financial market stability.  The Fed’s policy decisions are directly tied to global macro dynamics, not just the US economy’s idiosyncratic performance, since global factors influence US financial conditions. A more hawkish monetary policy narrative fuels dollar strength and equity and credit market weakness, which together constitute tighter financial conditions, raising downside risks to the US growth and inflation outlook, then prompting the Fed to soften its hawkish narrative. This triggers a rebound in markets which by definition eases financial conditions again, paving the way for the Fed to restart the countdown to rate liftoff; markets riot again, and the loop recirculates. This feedback mechanism exists because of the perception that easy Fed policy is the only variable sustaining financial markets in a growth and income-starved world.


An improvement in global growth is a prerequisite for severing the Fed’s dollar-feedback loop. Better global growth would trigger an improvement in non-US asset market sentiment and ease global financial conditions by spawning a durable rally in global equity and credit markets. This would weaken the dollar as capital flowed back into non-US markets, and as the dollar weakened from the stronger pulse of global growth, US inflation expectations would rebound, allowing for a steeper path for Fed rate hikes.

Unfortunately, such a scenario doesn’t appear likely over a 6 to 9 month horizon.




To find out more, click here to listen to BCA Chief Strategist Caroline Miller’s recent Webcast replay.

U.S. Equities: Bye-Bye Buybacks

One casualty from declining free cash flow in the U.S. could be stock buybacks.


U.S. businesses are no longer generating enough internal cash flow to fund operations. The corporate sector financing gap is historically wide, reflecting a heavy reliance on external funding. Corporate debt is growing faster than profits. The implication is that balance sheet flexibility is limited, which is a reliable indication of future repurchase activity.

To make matters worse, credit market risk appetite is drying up. Corporate bond yields are climbing steadily, and junk bond yields are well above earnings yields, eliminating the financial incentive to issue debt to retire stock. Even if that motivation still existed, the plunge in corporate bond issuance suggests there is little appetite for debt, which is needed to allow companies to repurchase shares.

The downside of this deterioration in corporate balance sheets is that a major support of overall EPS growth is likely to crumble. The NASDAQ Buyback Achievers Index is already underperforming, and overall shares outstanding are no longer falling, despite the plunge in new stock issuance.

A dwindling equity base has boosted return on equity (ROE) in recent years. Ergo, valuations could be at risk if ROE suffers over and above the negative impact from deteriorating profitability and flagging productivity.

Bottom Line: Poor earnings quality and deteriorating free cash flow are consistent with elevated stock market volatility and upward pressure on the equity risk premium. Stay defensive.