The dollar has been quietly rising without causing any losses to stock prices, but if the dollar strengthens further, stock prices could easily fall.
of
US dollar index,
The value against a basket of currencies is just above 105, up just over 3% from the lows reached in early March. This is because the rate of increase in yields on long-term U.S. government bonds has outpaced that of other countries such as Germany, Japan and the United Kingdom, making U.S. bond investments more attractive to own.
Investors must have dollars to take advantage of this.
The recent rally has put the dollar at a tipping point. Since the end of 2022, sellers have repeatedly emerged to push the dollar lower when the index reaches 106. If the dollar can break above 106, it would signal a break from a larger downtrend that has been in place since hitting a multi-decade high of 114 in 2020. If that happens, it seems likely that the dollar will continue to inch higher as long as buying interest remains fairly strong.
A strong dollar is a problem for stocks, but so far.
S&P500
Not responding. It is up double digits from its lows in late October and is up more than 1% since the start of the dollar’s recent rally.
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The prevailing view is that U.S. yields and the dollar will eventually fall. Inflation has long been seen as being subdued enough to allow the Federal Reserve to cut interest rates, but inflation has recently been trending upwards, making it possible for the Fed to delay lowering rates. Highly sexual.
If the dollar breaks out above $106, investors will have no choice but to assume that the dollar will remain strong going forward. “If the dollar index climbs towards above 106, we expect another headwind for stocks in the coming weeks,” wrote Tom Essay of Seven’s Report.
When the dollar is strong, U.S. companies that generate sales overseas (as many S&P 500 companies do) earn fewer dollars when converting their sales into dollars. This weighs on profits, especially for companies that derive significant amounts of revenue from outside the United States.
Such companies include Philip Morris International.
,
Nike
,
Micron Technology, Nvidia
,
apple
,
caterpillar
,
Merck
,
pfizer
,
and McDonald’s
,
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Among many others. The nine companies have a market capitalization of $6.2 trillion, accounting for nearly 15% of the S&P 500.
The earnings headwinds likely won’t fully manifest as companies report first-quarter results in the coming weeks. These reports cover the first three months of the year when the dollar was weaker than it is now. However, the stock market is forward-looking, and it is well known how a strong dollar affects earnings, so any further strength in the dollar is likely to be reflected in stock prices quickly.
Over the past three years, the dollar and the S&P 500 have often had a negative correlation, meaning that when the dollar rises, stock prices fall. From April to October 2022, the dollar soared and the S&P 500 plummeted. It happened again from late July to late October last year.
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Indeed, the dollar’s strength is likely to result from the strength of the U.S. economy, as healthy demand for goods and services will keep prices rising, making it less likely that the Fed will cut interest rates. It is unclear whether these economic forces will outweigh the negative impact of a stronger dollar.
But one thing is certain. The stock market doesn’t want the dollar to rise further.
Email Jacob Sonenshine at jacob.sonenshine@barrons.com.
