Don’t look for a bottom until the rising dollar cools off. Here’s why.


As the US dollar continues to rise against its rivals, it will be difficult for the stock market to stop sliding and find a bottom, according to market analysts.

Global stocks had a tough week, with the S&P 500 narrowly missing its lowest close of the year on Friday. At the same time, the main U.S. dollar index rose to its highest level in two decades as the dollar rose against rival currencies and heightened volatility in financial markets.

To see: These 20 stocks in the S&P 500 lost as much as 21.5% in another brutal week for the market.

Currencies such as the euro EURUSD, after the Fed raised its key policy rate by 75 basis points on Wednesday,
-1.50%,
British Pound GBPUSD,
-3.59%
and the Japanese yen USDJPY,
+0.69%
The US dollar index, DXY, fell further.
+1.50%
It hit its highest level since 2002 on Friday and marked its biggest weekly advance since March 2020.

The pound fell to a 37-year low against the dollar on Friday, while the euro fell below $0.98 for the first time. It fell to a 24-year low before Japan signaled intervention to boost the currency’s value for the first time since 1998.

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

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

The dollar’s sustained rise comes as investors shun riskier assets as they seek shelter from fears of a global recession. Analysts say the dollar’s appreciation is also the result of currency carry transactions, where investors borrow low-yielding currencies like the Japanese yen and convert them into high-yielding currencies like the U.S. dollar to capture higher interest rates.

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

“As the Fed becomes more hawkish, fixed income and then U.S. yields rise rapidly, which draws money into the U.S.,” said Brent Donnelly, president of Spectra Markets. “Then there’s also a feedback loop where higher yields make people nervous and sell off the stock, leading to a safe-haven buying,” Donnelly said.

5-year Treasury TMUBMUSD05Y,
3.987%
On Friday, yields hit their highest level since November 2007, while the 2-year yield TMUBMUSD02Y,
4.211%
It continued its rise towards the highest level of 15 years.

To see: BofA says a historic global bond market crash threatens to cancel the world’s most crowded auctions.

How can the appreciation of the dollar slow down?

A pause in monetary tightening by the Federal Reserve may serve to slow the dollar’s advance. However, with inflation still running high and the Fed determined to fight inflation, that seems a distant prospect.

Fed officials on Wednesday signaled they would tolerate a sharp cut as part of efforts to lower inflation, with the economy potentially tipping into recession. According to the Fed’s forecast, the unemployment rate will rise to 4.4% next year, which is 0.7% higher than the current unemployment rate. There has never been a time in history when the unemployment rate rose above about 0.5% without the economy going into recession.

“Until something breaks in the credit markets, the Fed will probably remain hawkish,” Donnelly said. “It will be the bursts in credit and stocks that break this cycle, ultimately causing the Fed to send a different message,” he said.

Some investors also hope that global central banks will take collective action to curb the appreciation of the dollar.

“In the past, when it became a concern, we would say that we can’t rule out a worldwide coordinated effort by central banks to stop the dollar’s growth, because that causes a lot of problems,” President and Chief Investment Officer Mace McCain said. Officer at Frost Investment Advisors.

McCain cited the Plaza Accord, a joint agreement signed in 1985 by the world’s largest economies to intervene in foreign exchange markets and devalue the US dollar against the French franc, German deutsche mark, yen and pound sterling.

In the current market environment, it may still be the safest bet for investors to hold US dollar-denominated assets, although they should prepare for the possibility that the global stock market or the dollar stabilizes in the coming quarters, he said. Brinker storied.

All three major stock indexes ended the week with losses. Dow Jones Industrial Average DJIA,
-1.00%
It lost 1.6% for the week ending on Friday at its lowest level since November 20, 2020. S&P 500 SPX,
-1.72%
It decreased by 1.7%. Nasdaq Composite COMP,
-1.80%
decreased by 1.8% during the week.

Next week, investors will look to the personal consumption expenditure price index, a key inflation gauge, due out on Friday.



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