The correlations between risk assets and risk-free ones have tended to revert to their historical (negative) level, though not yet on a consistent basis.
Currencies: The DXY index has shown more two-way movements in the last few weeks, trading in a range of 88.7 to 90.6.
Although these are early days still, there have been encouraging signs of the potential for a healthier asset price reset, despite some recent challenges, including the inconclusive outcome of elections in Italy, and market uncertainty about US trade policy and economic management. Yet the underlying strength of the US economy has been an important driver of progress.
The jobs report for February, released March 9, presented a vivid illustration of this. Going beyond a “goldilocks” snapshot of the labor market, it contained positives for both the demand and supply sides of the economy, as well as for the policy outlook.
The large size and diversified nature of the improvement in job creation were important reminders of continued economic dynamism that is increasing the possibility the US economy can leave behind too many years of a “new normal” involving low and insufficiently inclusive growth. Concerns that this may lead the Federal Reserve to increase rates more aggressively — that is, four or more hikes in 2018, instead of the three signaled earlier — were eased by muted wage growth and, more encouragingly, a solid increase in labor participation as previously discouraged workers were drawn back to the labor market.
Markets were also heartened by the tariff carve-outs for Canada and Mexico that the White House announced March 8, together with signals that other exemptions could be considered in the context of concrete steps toward fairer trade. This helped dampen concerns about stagflationary trade wars.
The economy and markets need to continue to build on all of this, including by making further progress on pro-growth structural reforms around the world, more balanced demand management in some advanced economies and greater efforts to strengthen the regional economic architecture in Europe. Remember, it’s not just the markets that are transitioning back to a more normal set of conditions for expected returns, volatility and asset-class correlations. This shift coincides and interacts with two other transitions: in policy, with the move away from excessive reliance on unconventional monetary policy, and in the underlying drivers of higher and more inclusive growth.
For now, there is around a 65-35 probability that all three transitions will be navigated ably, though with bumps along the way. And these are important historical transitions that speak to economic, financial, institutional, political and social well-being. If they are mishandled, the global economy would not revert back to the new normal of the aftermath of the financial crisis. Instead, it would most probably be victim to more periodic recessions, unsettling financial volatility, greater global trade tensions, and more complicated politics at both the national and regional levels.