Why a surging dollar could sink stocks, but help the Fed

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Microsoft Corp. It’s not the only US company pointing to the dollar’s boom as a potential problem.

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A strong dollar has been a hot topic this week since software giant MSFT,
-1.66%
and Salesforce Inc. crm,
-1.85%
Pointing out the challenges that the currency is creating for earnings. It has also been flagged off in other industries including Pfizer Inc., PFE.
+0.99%
eBay Inc., eBay,
-1.42%
and Mastercard MA,
-1.45%
Since a strong greenback could hurt overseas sales.

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“The strength of the dollar has been a story for a while,” said Deck Mularkey, SLC Management’s managing director of investment strategy and asset allocation. DXY Recently climbed to nearly 20-year highs, as measured against a basket of rival currencies.

“It may be a pinch for companies, but clearly it’s good for the Fed,” Mularkey said.

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A stronger dollar makes it more expensive for US companies to sell their goods in the international market, which could hurt the stock market. But cheaper imports from a stronger dollar help counter higher costs for American consumers, the lifeblood of the economy, especially for households like gas, groceries and more.

“The strong dollar is helping to keep inflation at bay,” Mularkey said. “It’s important with energy prices where they are.”

two sides of the dollar

A warmer dollar could also help the Federal Reserve achieve its “soft” landing for the economy as it works to quell inflation by rapidly raising interest rates over the next few months.

“The whole purpose of monetary tightening – to reduce liquidity – is also to strengthen a currency,” Ash Alankar, head of global asset allocation at Janus Henderson Investors, said over the phone.

“The most important battle that people have to consider is the Fed fighting inflation,” Alankar said. “At the end of the day, if the Fed can beat inflation, that’s ultimately going to determine whether the market is recovering.”

The ICE US dollar index was up 6.5% year over Friday and 13% higher than a year ago, according to FactSet data. Analysts at BofA Global said in a report on Thursday that the dollar could strengthen further this year if inflation falls at a slower pace than expected.

Analysts at Barclays called the dollar “remarkable market dynamics that have shown some signs of reduction” in a Friday client note, while appreciating inflation as well. As long as the dollar continues to rise, the team expects an even brighter spotlight on the currency in its upcoming corporate earnings report.

Analysts have already found management on approximately 20% of the companies in the S&P Composite 1500 Index SP1500 (see chart),
-1.59%
We have discussed foreign exchange as a headwind in this year’s earnings call, which has nearly doubled for a few quarters.

Management sees bullish forex as headwind

Barclays Research, Refinitiv

They also found that only 5% of the companies in the index described a strong dollar as a tailwind, a sharp decrease from recent quarters. The S&P 1500 Index covers approximately 90% of the market capitalization of the US equity market.

Investors have sought protection in safe havens such as the US Treasury loan TMUBMUSD10Y,
2.939%
And the dollar this year, as stocks and other risk assets have fallen on fears that the Fed may go too far in its sway over inflation and spark a recession. Another concern is that the high cost of living could go out of control for some time, potentially igniting a long-term carnage in the economy.

“Everything the Fed is doing is trying to slow inflation,” said Jack McIntyre, portfolio manager for global fixed-income strategy at Brandywine Global Investment Management. “But they are not doing so without slowing the economy and hurting equities.”

What’s more, McIntyre said that uncertainty about the path to lower inflation “doesn’t bode well for debt as an investment vehicle.”

In the dire 2022 crisis for investors in stocks and bonds, the total return for the US investment-grade corporate bond LQD,
-0.32%
were negative 12.1% on the year through Friday, and minus 8% for the higher yield, HYG,
-0.74%

JNK,
-0.77%
According to Mizuho Securities.

McIntyre expects the Fed to keep fiscal conditions tight until inflation eases to a range of 3% from April’s 8.3% annual rate.

“It goes back to a tough spot on the Fed,” he said by phone. “To break the back of inflation, you have to tighten policy until that happens.”

US stocks made a brief return after the Memorial Day surge at the end of the week in the red, with the S&P 500 index SPX,
-1.63%
Dow Jones Industrial Average DJIA, booking 1.2% weekly loss
-1.05%
For the week, the Nasdaq Composite Index was down 0.9% and the Nasdaq Composite Index, according to FactSet.

Next week, US economic data will include a consumer credit update on Tuesday, followed by revised wholesale inventory data on Wednesday. The housing and jobless claims figures will be released on Thursday. But the biggest Friday will be the release of the May Consumer Price Index.

ReadingFed will only need to get rates up to 3% to calm inflation, say big bank economists

Credit: www.marketwatch.com /

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