The U.S. dollar continues to soar: What that means for the stock market and investors

Amid all the wild volatility of 2022, there’s one thing investors can still count on: the rising US dollar.

The ICE US Dollar Index DXY,
-0.07%,
which measures the US currency’s strength against a basket of six other currencies, rose 0.7% on Wednesday as the greenback continued to crush key counterparts including the yen USDJPY,
+0.01%
and pounds GBPUSD,
+0.13%,
while generally wreaking havoc around the world.

This comes at a time when all three major stock indexes DJIA,
-0.33%

SPX,
-0.67%

comp,
-8.76%
are falling deeper into double-digit percentage losses this year, global government bonds are mired in one of their biggest bear markets on record, and even gold has had a choppy year.

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Read: A raging US dollar just posted its strongest quarter in at least 7 years as investors seek safety

To understand why the dollar is so far outperforming other assets, despite projections pointing to a 100 percent certainty of a US recession in the next 12 months, it makes sense to take a step back.

First, currencies are always traded relative to what’s going on anywhere else in the world, and right now, rapidly rising US interest rates relative to other countries are the primary reason for the dollar’s appreciation. In technical jargon, this is known as the interest rate differential or difference in central bank monetary policy.

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The US Federal Reserve is determined to lower inflation with continued aggressive rate hikes, especially after September’s hotter-than-expected CPI returned interest rates of 8.2% yoy. Meanwhile, Europe – which on Wednesday reported annual inflation for September at 9.9% – is facing an energy crisis that the International Monetary Fund says is putting the European Central Bank on a flatter interest rate path. And in Asia, still-low inflation in Japan and China has allowed central banks there to buck the global tightening trend.

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Around the world, this interest rate differential is weakening a number of currencies against the dollar.

The dollar’s strength has been so relentless that even questions have been raised about whether there needs to be a 1985 Plaza Accord-style intervention, though analysts doubt a coordinated effort to control the greenback will happen. A key reason is that a strong dollar helps keep domestic inflation low by lowering import costs, thereby helping the Fed to some extent do its job.

Read: Why a rising dollar raises questions – and doubts – about Plaza Accord-style intervention

Source: Haver Analytics, IMF staff calculations. Data as of October 4, 2022.

“The battle right now is the speed at which this dollar strength has come, where it can become intense and problematic,” said Tom Nakamura, portfolio manager and currency strategist at Toronto-based AGF Investments, which has C$38.4 billion ($27.8 billion). US dollars) managed. from Sept.

“Such a strong move could trigger a liquidity or credit crunch as companies in other countries try to meet their dollar-denominated obligations. I don’t think it’s that far. But speed is important, be it in FX or interest rates, because there is a process of adjustment. The faster it happens, the less likely it is that economies around the world will be able to adapt and absorb it smoothly,” he said.

explained DXY

There are a number of ways to assess the dollar’s performance, and one of the most common is to use the ICE US Dollar Index, which is calculated approximately every 15 seconds from a feed of spot rates for various currencies. Six currencies – the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona and the Swiss franc – are weighted against the dollar to create a calculation of the US currency’s performance.

The index is up nearly 18% in 2022, trading just 1.6% below a more than two-decade high hit in late September, according to FactSet.

Interestingly, Brent crude is the only asset this year to have managed to outperform the US dollar index, according to numbers released Monday by the BlackRock Investment Institute, the research arm of the world’s largest wealth manager.

Sources: BlackRock Investment Institute, Refinitiv. Data as of October 13, 2022.

wrecking ball

You may have heard the dollar called a wrecking ball recently, and it’s easy to see why. For one thing, foreign governments and private companies have billions of dollars in debt that they are struggling to repay. Second, US multinationals that do business in multiple countries are seeing their profits and sales decline.

Based on a published estimate by Credit Suisse Group AG, every 8% to 10% appreciation in the dollar causes US corporate earnings to fall by about 1% on average.

Read: Inflation is yesterday. A strong dollar is the next big threat for US multinationals.

American companies have been bemoaning the greenback’s rise since at least June, and this week provided further evidence of how much the strong dollar is taking its toll.

Johnson & Johnson JNJ,
-0.80%
said it sees pressure from the U.S. currency and lowered its sales forecast for the year, despite reporting third-quarter earnings that beat estimates. streaming giant Netflix NFLX,
+13.09%
coupled dollar strength with a weaker fourth-quarter outlook, and Procter & Gamble PG,
+0.93%
Blamed the greenback and rising inflation for the fiscal year’s earnings, which are likely to be on the low end of the company’s own forecasts.

James Solloway, chief market strategist at SEI, which manages about $1.3 trillion in assets, said he would not be surprised if the dollar reversed its trend temporarily. Meanwhile, a team at JPMorgan Chase & Co. said that with investors fleeing almost every asset class this year and cash on the verge hitting a 10-year high, “we’re looking at the dollar as a hedge against a tightening Fed in the near future.” keep the future long”. Expression.”

Stock portfolios take a hit

While not always the case, analysts say the strong dollar has added significantly to headwinds for the US stock market this year.

According to a report by RBC Capital Markets, this is a “clearly negative” for the S&P 500, with industrials, materials, consumer staples and technology the most sensitive to a stronger US currency. In contrast, stocks in sectors like financials, utilities and real estate mutual funds should be more isolated, it said.

Read: According to RBC, the US dollar’s dominance tends to hurt these sectors of the stock market less and the dollar keeps hitting new highs. The stock market doesn’t like that.

At least there is Paris

Plane flies over Los Angeles International Airport.

Getty Images

Investors with throbbing headaches from double-digit stock market losses in 2022 can be forgiven for wanting to walk away if they still have the cash.

Today’s strong dollar benefits American travelers when it comes to booking hotel stays and paying for dining and fun excursions in Europe, the UK, Japan and almost everywhere else.

See: The strong dollar is currently making travel in Europe very attractive – with one important caveat

Some of the cheapest places to travel with US dollars are Costa Rica, Vietnam and Romania – although any place outside of the 50 states will do. Some well-heeled Americans are taking it a step further by investing in European homes, where a single purchase can end up being tens of thousands of dollars cheaper than earlier this year.

“The concept of dollar strength can be good in a variety of situations,” AGF Investments’ Nakamura said by phone on Wednesday. “It could ease inflationary pressures that would otherwise have been stronger domestically. Foreign exporters can benefit from weaker currencies against the dollar, meaning Americans can enjoy cheaper imported goods. The average American can also benefit from a dollar that continues to expand as they travel abroad.”

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