As of 06-30-2017

Market Overview

Introduction to the second quarter of 2017

The second quarter of 2017 was fairly nondescript for most global asset classes, typified by exceptionally low volatility and modest returns. As is typically the case in financial markets, there were exceptions to this rule.  European politics and the energy sector were two standouts.  Uncertainty over the French presidential elections and oil’s (West Texas Intermediate’s) nearly 18% decline in June temporarily destabilized risk assets and provided support for global bonds.  However, the change in rhetoric by the world’s leading central banks was possibly the single biggest occurrence during the quarter.  This monetary sea change was spearheaded by the European Central Bank (ECB), which after years of aggressive stimulus, began to telegraph a more balanced and optimistic outlook.  It is important to note, however, that despite oil’s steep decline and the change of tone from central banks, realized volatility remained particularly subdued in global equity, bond and currency markets.  In addition, returns were fairly controlled and orderly during the reporting period.  This listlessness ultimately found its way into the options market as many implied volatility premiums began to teeter on multi-year lows.

Undeterred by lukewarm economic data, it was “full speed ahead” for U.S. monetary tightening.  The Federal Reserve (Fed) increased its federal funds target rate by 25 basis points in June and also released policy normalization guidelines. Ironically, as the Fed grew more constructive, U.S. economic data began to disappoint forecasts.  Notably, core CPI surprised to the downside throughout the entire three month period.  These were somewhat confounding signals for bond investors who found themselves divided by a more hawkish Fed and a subdued economic reality.  The U.S. dollar, however, heeded greater attention to the data.

Currency markets to date have fully rejected the U.S. fiscal reflation narrative and have given back practically the entire “Trump rally” that began in late 2016. Specifically, the Dollar Index (DXY) was down 4.71% for the 3-month period. In the developed world, the dollar lost ground to nearly all of its G10 peers. Despite the hawkish tilt from the ECB, the Bank of England and the Fed, capital markets still managed to reap healthy gains during the quarter.  The MSCI World Equity Index posted a 3.38% return during the period, while the Bloomberg Barclays Global Aggregate Index gained 2.60%. 


Admirably, Japan has thus far evaded much of the political instability that has plagued so many other economies. Under the Abe administration, Japan’s political stability has been remarkable; a coveted distinction these days.  On the economic front, GDP statistics further highlighted the ongoing softness in core domestic demand. However this downturn appears at odds with the tight labor market.  During the period, Japanese unemployment reached 2.8%, the lowest reading since 1995.  Additionally, CPI inflation started to exhibit some bottoming symptoms.

During the reporting period, the Bank of Japan (BoJ) kept its short-term rate at -0.1% and its target for the 10-year Japanese government bond yield at around 0%. The BoJ also retained its guideline on Japanese government bond (JGB) purchases.  It said it will continue to buy JGBs at "more or less the current pace".  Overall, the BoJ kept its assessment of the economy unchanged; one of the few remaining G10 central banks to do so.  This growing divergence between Japanese monetary policy and that of other major central banks eroded demand for the yen.  Consequently, the Japanese yen was the only G10 currency that lost ground to the USD, -0.89%. 

Commodity-Linked Countries:

The economies of the commodity‑bloc trio, Australia, New Zealand and Canada fared out reasonably well in the second quarter of 2017. The dynamics behind each economy, however, were quite different for each of the three countries.  In Australia, employment beat expectations for three months in a row. In June, for instance, the jobs report was much stronger than expected; with total employment rising 42 thousand (consensus: +10k). The strong headline increase was accompanied by a lower unemployment rate of 5.5%, the lowest it has been since March 2013.  The Australian dollar returned 0.79% during the reporting period.

The Reserve Bank of New Zealand (RBNZ) left its Official Cash Rate (OCR) unchanged at 1.75% in the second quarter.  The ensuing message from the RBNZ, however, continued to express confidence in global economic growth, which the central bank characterized as “becoming more broad-based.”  The optimistic tone was a key variable in the New Zealand dollar’s nearly 5% gain against the USD in the quarter.  Additionally, the New Zealand dollar’s strength was largely ignored by the central bank, which had routinely rebuked the slightest appreciation in past periods.

With oil prices down nearly 16% in June alone, one would think that the Canadian dollar would have suffered as a consequence. That assumption would have been flawed.  In fact, the Canadian dollar (Cad) in June was the best-performing G10 currency.  Over the course of the last three months, the Canadian dollar appreciated 2.73%.  The reason behind both the currency and bond performance was straightforward, the Bank of Canada (BOC).  The central bank indicated a clear shift in view, sounding more upbeat and encouraging.  


Early in the quarter, U.K. Prime Minister Theresa May surprised markets by announcing an early snap general election. The move was essentially geared at strengthening her majority in the House of Commons and paving the way for a smoother path to implement Brexit.  However, as the old adage goes: “Be careful what you wish for.” In June, the election results did not exactly proceed as planned.  Prime Minister May lost the majority in the election and by doing so unveiled uncertainties about her leadership and the new administration.

Despite political unease, shoppers still splurged in the U.K. Total retail sales volume increased 2.4% month-over-month in May alone.  Retail strength was broad based, with non-food store goods posting a formidable gain.  It appeared as if the U.K. consumer was undeterred by the prospects of leaving the open market of Europe.

The Bank of England MPC left monetary policy unchanged during the reporting period, but surprisingly backers for a rate hike increased to three members. Those supporting a future rate hike emphasized tighter labor market conditions and more pronounced inflation.  The British pound gained 3.78%. 


The hallmark event for Europe this past reporting period was the French presidential election. The results confirmed the widely-favored scenario of Emmanuel Macron winning the presidency, with a margin that was even wider than the first round polls had suggested. With the political clouds out of the way, economic fundamentals came back into focus; and those too showed promise.  For instance, Spanish GDP came in above forecast at 0.8% and unemployment fell to the lowest level in almost eight years.  In Portugal, first quarter GDP measures surprised to the upside, with growth reaching 1%; 0.3% faster than the prior quarter.

In the core European countries, the economic story was similar to that of the periphery—promising. The German economy appeared to be firing on all cylinders, with a surge in sentiment indicators.  Business confidence rose to the highest since 1991, while manufacturers saw the fastest growth in six years.  German consumer spending, investment and exports all contributed to growth in the first quarter, helping the economy to expand 0.6%; its strongest performance in a year.  Germany’s IFO survey also suggested that the economy is gathering momentum.  Lastly, French PMI releases in May depicted decent growth momentum in the euro-area’s second largest economy.  Specifically, the French composite PMI reading rose to a new multi-year high of 57.6 in May.

The ECB left policy rates largely stable in the second quarter, but made some major alterations to its guidelines. In June, the ECB declared that interest rates would not be reduced further; a first step towards normalization.  Additionally, ECB President Mario Draghi noted that the risks to the euro region had become much more balanced and that tail events had practically disappeared.  Specifically, Mr. Draghi cited that “while there are still factors that are weighing on the path of inflation, at present they are mainly temporary factors that typically the central bank can look through.”  These very comments sparked a sell-off in German bunds, but soon began to infiltrate other global bond markets.  Lastly, the euro was the prime beneficiary from the ECB comments and gained 7.27%, making it the second best-performing G10 currency in the second quarter of 2017.

Fund Performance

During the reporting period, Federated Prudent Dollar Bear Fund had a total return of 4.67% (Institutional Shares at NAV). The return for the inverse of the U.S. Dollar Index (DXY) was 4.71% for the same period.  The fund’s absolute return was largely the effect of U.S. dollar weakness against the majority of the G10 economies. The fund’s total return also reflected actual cash flows, transaction costs and other expenses that were not reflected in the total return of the index. 

Performance data quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than what is stated. Other share classes may have experienced different returns than the share class presented. To view performance current to the most recent month-end and for after tax returns, click on the Performance tab.

Click the Performance tab for standard fund performance.

An overweight allocation to the Mexican peso improved performance relative to the inverse of the U.S. Dollar Index (DXY). An underweight allocation to the New Zealand dollar, on the other hand, detracted from overall fund performance relative to the inverse of the DXY index. Additionally, as oil prices declined, an underweight allocation to the Russian ruble enhanced fund return relative to the inverse of its index, DXY. 

Strategy and Positioning

“Is the era of easy money coming to an end?” is a question likely to populate headlines, speeches, debates and consume global risk premiums in the quarters to come. More hawkish central bank rhetoric has already broken ground and is primed to become the focal macro thesis.  However, like so many things in finance, “how” these events unfold will be just as important as the “if” component of the narrative. 

The timing and magnitude of global monetary tightening will be as essential to dissect as the actual tightening itself. Too rapid of a pace could have vastly different ramifications on asset prices than one that is more methodical.  Fund management is keenly aware of this subtle, yet critical contrast and is prepared to address either outcome.  Historically, the fund has always placed an exacting emphasis on liquidity premiums, a hallmark characteristic that will allow the portfolio to nimbly adjust to changes in global monetary regimes. 

As the economy in Europe continues to improve and heal, the region’s economic immunity system has grown more robust, and consequently less prone to tail risks. Recently, the ECB vocalized its confidence in the economy, which roused inference to when the central bank will begin to taper its long-standing quantitative easing (QE) program.  GDP expansion in the EU has been on a steady march upward, but pricing pressures have been underwhelming, if not disappointing.  ECB tapering is an inevitable outcome, but forecasts for a late-year taper may prove too hasty.  Fund management believes that European pricing pressures appear too fragile at the moment to warrant any tapering in 2017.  Regardless of timing, attention to inflation pressures should be assigned a greater weighing than to hard economic data in assessing the ECB’s outlook on QE. 

Viewpoints for the United Kingdom have grown more hawkish in recent months by both the investment community and the Bank of England itself. However, fund management is not particularly as optimistic on the U.K. economy as many seem to be.  Ultimately, Brexit entails more questions than it does answers, and inherently it is the questions, and not the answers, that present the risks.  Furthermore, the current inflation surge in the U.K. could very well prove to be just a transitory byproduct of the British pound’s steep decline in 2016 and little else.  Furthermore, the once resilient retail and housing sectors have begun to exhibit some early warning signs of contraction.  Consequently, fund management is not as optimistic on the U.K. economy as the general outlook and has modified its portfolio holdings to reflect this viewpoint.

There has been a growing body of evidence that eurozone affairs are steadily improving, while the U.S. reflation thesis is simply failing to materialize. These dual factors have contributed to the euro’s nearly 8.3% gain against the dollar this year, making it the best-performing currency versus the dollar within the G10.  However, protracted euro appreciation could ultimately undermine the ECB’s objectives by stifling an already fragile, inflationary backdrop.  So far this year, the dollar has endured losses against a host of currencies despite two rate hikes by the Fed.  The election of Donald Trump opened a new chapter into what was already a protracted dollar bull cycle.  Few doubted the imminent arrival of fiscal expansion, tax reforms and repatriation incentives.  However, facts quickly turned into fictions, and reflation promises faded.  Emerging-market currency strength has been quite evident all year, but dollar weakness also has begun to permeate most developed economies.  Absent any new meaningful initiatives from the Trump administration, the bull cycle is beginning to show its age.  In the coming months, fiscal initiatives likely will prove the most important factor in determining the fate of the U.S. dollar.