Don’t look for a stock market bottom until a rising dollar has calmed down. Here’s why.

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It will be difficult for the stock market to stop its slide and find a bottom as long as the U.S. dollar continues to soar against its rivals, market analysts say.

Global equities suffered a bruising week, with the S&P 500 narrowly avoiding its lowest close of the year on Friday. Meanwhile, a key U.S. dollar index hit its highest level in two decades, with the greenback surging against rival currencies and sowing volatility in financial markets.

See: These 20 S&P 500 stocks slipped as much as 21.5% in another brutal week for the market

After the Fed raised its key rate by 75 basis points on Wednesday, currencies such as the euro EURUSD,
-0.03%,
British Pound GBPUSD,
-0.06%
and the Japanese yen USDJPY,
+0.69%
plunged further, while the US dollar index DXY,
+1.50%
Friday hit its highest level since 2002 and saw the biggest weekly advance since March 2020.

The pound fell to its lowest level in 37 years against the dollar on Friday, while the euro fell below $0.98 for the first time. The in hit a new 24-year low, before Japan said on Thursday it had intervened to support the value of the currency, the first time since 1998.

According to Nicholas Colas, co-founder of DataTrek Research, non-US currencies need to stabilize before international stock markets can find a “sustainable bottom.” Looking back, a strong dollar in turbulent markets has been a fundamental sign of market stress since the early 2000s, Colas said in a recent note.

Still, the relationship between a strong dollar and global market turbulence is a “chicken and egg” problem, said Brian Storey, senior portfolio manager at Brinker Capital Investments.

The dollar’s continued rally comes as investors dump assets seen as risky as they seek safe havens amid fears of a global recession. The surge in the greenback is also partly the result of currency carry trades, where investors borrow low-yielding currencies, such as the Japanese yen, and convert them into high-yielding currencies, such as the US dollar, to benefit from higher interest rates, analysts said.

The US federal funds rate currently has a target range of 3% to 3.25%, while the Japanese central bank has kept interest rates negative.

“As the Fed becomes more hawkish, fixed income and then US yields are rising rapidly, drawing money into the United States,” said Brent Donnelly, president of Spectra Markets. “Then there’s also a feedback loop, where higher yields make people nervous and sell stocks, which also leads to safe haven buying of dollars,” Donnelly said.

The 5-year Treasury TMUBMUSD05Y,
3.987%
on Friday, the yield headed to its highest level since November 2007, while the 2-year yield TMUBMUSD02Y,
4.211%
continued its ascent to a 15-year high.

See: Historic global bond market crash threatens liquidation of world’s most crowded deals, says BofA

How could the dollar rally slow down?

A pause in monetary tightening by the Federal Reserve could slow the dollar’s advance. However, with inflation remaining high and the Fed resolute in its fight against inflation, this seems like a distant prospect.

Fed officials signaled on Wednesday that they would tolerate a hard landing, with the economy potentially falling into recession, as part of its efforts to bring inflation down. According to Fed forecasts, the unemployment rate will reach 4.4% next year, 0.7% higher than the current unemployment rate. In history, there has never been a situation where the unemployment rate increased by more than about 0.5% without the economy entering a recession.

“Until something breaks, probably in the credit markets, the Fed is going to stay hawkish,” Donnelly said. “What will eventually break this cycle will be an explosion in credit and equities that will ultimately lead to the Fed sending a different message,” he said.

Some investors also remain hopeful in the collective actions of global central banks to curb the surge in the dollar.

“In the past, when it got uncomfortable, we would say we can’t rule out a coordinated global effort by central banks to stop the rise of the dollar, because it’s causing so much trouble,” noted Mace McCain, president and chief investment officer. . agent at Frost Investment Advisors.

McCain cited the Plaza Accord, a joint agreement signed in 1985 by the world’s largest economies to depreciate the US dollar against the French franc, German Deutsche Mark, yen and pound by intervening in the changes.

In the current market environment, it may be even safer for investors to hold US dollar-denominated assets, although they should also be prepared for the possibility that the global stock market, or the dollar, will stabilize in the future. over the next several quarters, said Brinker’s Floor.

The three main stock indices ended the week with losses. The Dow Jones Industrial Average DJIA,
-1.00%
lost 1.6% over the past week, ending Friday at its lowest since Nov. 20, 2020. The S&P 500 SPX,
-1.72%
fell 1.7%. The Nasdaq Composite COMP,
-1.80%
fell 1.8% for the week.

Next week, investors will be watching the Personal Consumption Expenditures Price Index, a key indicator of inflation, which will be released on Friday.

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