The biggest threat to investors today – the US recovery

published 8 December 2014

141208-us-eocnomy-2 — As Americans spend more, the rest of us get hit by a rising dollar

It's been a tough few years since the financial crisis. But life is getting better in the US, no doubt about it.

America posted a stunning set of employment figures on Friday. In November, more than 320,000 new jobs were created. That absolutely trounced the 230,000 predicted by economists. Previous months' figures were revised higher too.

I'll be the first to say that it's stupid to base your entire investment strategy on one set of volatile figures. But the trend here is clear. Americans are getting jobs fast.

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Good news? It certainly is for the man and woman in the street.

But for investors, it could make life very tricky indeed.

Why a recovery in the US could derail financial markets

A significant chunk of the population has had to cope with unemployment, low-to-negative savings interest, and frozen wages.

But anyone with the available capital and gumption (or foolhardiness) to invest and the ability to stay invested has done very well indeed.

However, that might now be set to turn around. And it boils down to one main thing the US dollar.

The US currency ended last week at its highest level in eight years. There are good reasons for that. The strong jobs data means the economy is getting stronger. That means that the Federal Reserve will be under pressure to raise interest rates more quickly than investors had expected.

All else being equal, higher interest rates tend to make a country's currency more attractive. It's just like a bank account if one bank offers a higher interest rate than another, then you're likely to opt for the higher rate, unless there's an obvious reason not to.

So why might a stronger US dollar make life tricky for investors? In short, it's because the US dollar is the world's reserve currency. Almost everyone uses it for something.

So when the US dollar strengthens ie the US dollar gets more expensive monetary policy around the world gets tighter, because dollars cost more. And for a market that has been driven higher by cheap money, that's bad news.

Emerging markets are already being hit by the stronger dollar

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The Bank for International Settlements (BIS) is often described as the central bankers' central bank. It warned yesterday of how a strong dollar could expose many emerging markets by making it harder for companies who have borrowed in US dollars to pay their debt.

As the FT points out, many governments in Latin America and Asia have learned painful lessons from currency crises of the past. As a result, they no longer peg their currencies to the dollar. But "companies in emerging markets have been borrowing heavily via the issuance of dollar securities in recent years".

But it's not just emerging markets. More generally, tighter monetary policy could reveal areas of underlying weakness that free-flowing credit is currently concealing.

For example, the BIS also highlights a recent melt-up' in US bond prices that happened on 15 October.It didn't last long, but only because the central bank intervened.

Can money printing by other countries offset the US tightening? Potentially. But poor old Mario Draghi is clearly having a struggle dragging the Germans over to his side of the table when it comes to quantitative easing.And the Japanese can't necessarily provide enough stimulus for the entire world themselves.

In the longer run, expect more money printing

Of course, central bankers aren't likely to take too kindly to another crash. Researchers on global money flows, Crossborder Capital, suggest that as a result, we may end up seeing both the US and China forced into doing more quantitative easing later next year. That would push asset prices higher once again.

In the meantime, we'd suggest sticking with Japan (where money-printing is happening) and Europe (where we'd expect money printing to happen). It's also worth getting US dollar exposure, as we've mentioned many times in recent years you can find out more about how to do it in this recent MoneyWeek story.

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.