Don't look for a stock market bottom until a soaring dollar cools down. Here's why.
By Frances Yue
Soaring currency stirring volatility across financial markets
It will be difficult for the stock market to stop its slide and find a bottom as long as the U.S. dollar keeps soaring versus its rivals, according to market analysts.
Global stocks suffered a bruising week, with the S&P 500 on Friday narrowly avoiding its lowest close of the year. At the same time, a key U.S. dollar index soared to a two-decade high, with the greenback soaring versus rival currencies and sowing volatility across financial markets.
See: These 20 stocks in the S&P 500 skidded as much as 21.5% during another brutal week for the market
After the Fed raised its key policy rate by 75 basis points on Wednesday, currencies such as the euro , British pound and Japanese yen further plunged, while the U.S. dollar Index on Friday rose to its loftiest level since 2002 and recorded the biggest weekly advance since March 2020.
The pound fell to a 37-year low against dollars on Friday, while euro dropped below $0.98 for the first time. The en tanked to a fresh 24-year low, before Japan said Thursday it had intervened to prop up the currency's value, the first time since 1998.
Non-U.S. currencies need to stabilize before international stock markets can find a "durable bottom," according to Nicholas Colas, co-founder of DataTrek Research. Looking back, a strong dollar in tumultuous 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 turmoil is a "chicken and egg" problem, said Brian Storey, senior portfolio manager at Brinker Capital Investments.
The dollar's continued rally comes as investors ditch assets viewed as risky as they look for havens amid fear of a global recession. The greenback's surge is also in part a result of currency carry trades, where investors borrow low-yielding currencies, such as Japanese yen, and convert them into high-yielding currencies, such as U.S. dollars, to capture higher interest rates, analysts said.
The U.S. federal-funds rate currently has a target range of 3%-3.25%, while the Japanese central bank has maintained its negative interest rates.
"As the Fed gets more hawkish, fixed income and then U.S. yields are rising quickly, and that's attracting money to the U.S.," said Brent Donnelly, president at Spectra Markets. "Then there's also a feedback loop, where the higher yields are making people nervous and selling equities, which leads to a safe haven buying of dollars as well," Donnelly said.
The 5-year Treasury yield on Friday headed for its highest level since November 2007, while the 2-year yield continued its climb toward a 15-year high.
See:A historic global bond-market crash threatens the liquidation of world's most crowded trades, says BofA
How could the dollar rally slow down?
A pause in monetary tightening by Federal Reserve could serve to slow the dollar's advance. However, with inflation remaining heated and the Fed resolute in its fight against inflation, that appears to be a distant prospect.
Fed officials on Wednesday signaled that they would tolerate a hard landing, with the economy potentially falling into a recession, as part of its effort to bring down inflation. 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. In history, there has never been a situation where the unemployment rate rose more than about 0.5% without the economy entering recession.
"Until something breaks, probably in the credit markets, the Fed is going to stay hawkish," Donnelly said. "What eventually breaks this cycle will be blowups in credit and in equities that eventually lead the Fed to send a different message," he said.
Some investors are also keeping their hope up on collective actions by global central banks to rein the dollar's surge.
"In the past, when this has become uncomfortable, we'd say we cannot rule out a coordinated worldwide effort by central banks to stop the increase in the dollar, because it's causing so many problems," noted Mace McCain, president and chief investment officer at Frost Investment Advisors.
McCain cited the Plaza Accord, a joint agreement signed in 1985 by the world's largest economies to depreciate the U.S. dollar in relation to the French franc, the German Deutsche mark, yen and pound by intervening in currency markets.
In the current market environment, it may be still be the safest play for investors to hold assets denominated in U.S. dollars, though they should also prepare for the possibility for global equity market, or the dollar, to stabilize sometime in the coming quarters, said Brinker's Storey.
All three major stock indexes ended the week in losses. The Dow Jones Industrial Average lost 1.6% during the past week, ending Friday at its lowest since Nov. 20, 2020. The S&P 500 dropped 1.7%. The Nasdaq Composite declined 1.8% for the week.
Next week, investors will be eyeing the personal-consumption expenditures price index, a key inflation gauge, to be released Friday.
(END) Dow Jones Newswires
September 24, 2022 14:08 ET (18:08 GMT)
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