Dagmara Fijalkowski, Head of Global Fixed Income and Currencies, RBC Global Asset Management Inc., shares her view on how recent geopolitical events may affect global bond markets. In addition, Dan Mitchell, Senior Portfolio Manager, RBC Global Asset Management Inc., lays out the factors that are influencing the current U.S. dollar weakness.
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Dagmara Fijalkowski - How will recent geopolitical events affect global bond markets?
Already experienced fear and relief as yields have been drifting lower from the high of 4.8%. Canadian bonds outperformed, driven by unwavering pessimism and fueled by tariff threats. Both markets, U.S. and Canada, did very well compared to European or Japanese bonds. The question is, will that divergence in performance continue? The meeting between President Zelensky and Trump and VP Vance in the Oval Office changed everything.
February 28th, 2025, will be remembered as the day Europe got a cold shower from the U.S., which motivated members of EU to unshackle their fiscal constraints and approve spending on defense. Bond yields had extreme one day move, 30 basis points up, highest one day move since 1990. Stock market in Germany reacted very well as both have been driven by new growth expectations.
Bond yields trading still 150 basis points below U.S. treasuries are at risk of moving further up. The outlook for major bond markets have rarely been so differentiated. The theme we have been thinking about has been the onset of U.S. exceptionalism. Driven by growth, immigration and fiscal easing, AI, the theme has been priced in rates and strong dollar for a couple of years now.
Optimism about the impact of Trump's good policies, such as deregulation, tax cuts or improving government efficiency fueled the last few months of that theme, just prior to inauguration. And then, the avalanche of executive orders brought focus to bad policies like arbitrary tariffs or mass firings of government workers. The optimism balloon has been picked and the doubts about growth started creeping in.
The bottom line is that the U.S. exceptionalism is chipped away. From the U.S. side, revisions down and from rest of the world side, provisions are up. And yet, yields are priced for the environment with no recession in the U.S. over the next decade. So, we believe U.S. Treasury bonds offer good value. After all, growth expectations are too high, bond yields are still near post-pandemic highs and inflation is much lower.
Dan Mitchell - What factors are influencing the current U.S. dollar weakness?
Things have really heated up in the currency markets and are now a lot more interesting than the muted volatility andd the tight trading ranges from the past two years, And the aftermath of the U.S. elections, markets had been positioning for tariffs as U.S. dollar positive. And the dollar did in fact rally when those tariffs were first imposed on Canada and Mexico in early February.
But the one month delay in their implementation and then the on again, off again headlines from the White House have created a sense of fatigue around that trading theme, and meant that the U.S. dollar strength was actually very short lived. Meanwhile, we've got a number of new elements that have conspired to weigh on the greenback and undo some of that U.S. dollar strength from the past few months.
The first is a realization that the U.S. economy is likely to first experience a bit of pain, from tariffs and from government job cuts, before any positive impact comes through from President Trump's proposed deregulation and tax cuts. This kind of has investors scaling back their expectations of this so-called U.S. exceptionalism theme, and consequently reevaluating whether they should be so heavily invested in U.S. assets.
A second and related factor is that the lower U.S. growth profile has caused markets to price in more interest rate cuts from the Federal Reserve, and the lower yield actually diminishes the attractiveness of parking your money in the U.S dollar. Third, there's been a notable shift in the willingness of European governments to unleash fiscal stimulus, particularly around defense and infrastructure spending.
We don't have much by way of details around those fiscal plans, but the shift in tone was something that traders have been waiting for before moving some money back to Europe, and it's had an impact. It's just a couple of days in early March, the euro has rallied by about 5% on that news. So those three big developments have acted as a trigger for investors to shift their dollar outlook from positive to negative.
And if that proves to be a lasting regime shift for currency markets, we're likely to see some significant U.S. dollar weakness over the next few years. And as the market focuses on the structural U.S. dollar negatives that we've been highlighting for many quarters. These include large trade and budget deficits, the long term theme of dollarization, the fact that global investors are already very, very heavily invested in U.S. assets.
And of course, the fact that the U.S. dollar is extremely overvalued. At RBC Global Asset Management, we expect further declines in the U.S. dollar from here, and are forecasting widespread gains across most emerging and developed market currencies.