How the dollar is beating stocks and bonds and hurting big business

These are tough times for most investments. But it’s been a wonderful stretch for the dollar.

You might not have noticed this if you haven’t traveled abroad and traded dollars for euros, yen, or almost any other major currency. But many forex traders, S&P 500 executives, and economists certainly did.

The US dollar index, which tracks the dollar against six other major currencies, is hovering at levels it hasn’t seen in 20 years. Since the start of the year, it has gained 8%; over the past 12 months, it has increased by 14%. Against the Japanese yen, the dollar has risen more than 13% this year alone.

The latest steps taken by the Federal Reserve to tighten monetary conditions should further boost the dollar. Fed policymakers moved on Wednesday to raise short-term interest rates by half a percentage point and begin cutting obligations on its $9 trillion balance sheet in June.

Continued interest rate increases are likely in the Fed’s efforts to reduce inflation. While rising rates can be expected to make stocks, bonds and mortgage rates more volatile, chances are they will make the dollar shine.

Basically, a flood of foreign money into American businesses and investments drove up the value of the dollar.

In fact, various actions that have destabilized the stock and bond markets have combined to boost the value of the greenback against other currencies. These include Fed rate hikes, Russia’s war in Ukraine, global sanctions on Russia, soaring commodity prices, China lockdowns and economic slowdowns in the US. Europe and Japan.

Against this backdrop of faltering global economies and geopolitical instability, global demand has increased for relatively safe, increasingly high-yielding assets like treasury bills. The U.S. economy may be in a precarious position, but relative to other countries it has recovered well from the pandemic recession, its markets remain deep and relatively stable, and the interest rates offered on its government bonds are generous.

The Fed’s commitment to fighting inflation by raising interest rates can be expected to drive Treasury yields even higher. This could make them even more attractive compared to low-yielding bonds from countries like Germany, Japan and China, which have eased local monetary conditions, not tightened them. Already, the yield differentials, or spreads, are significant. These are the yields on 10-year government bonds.

  • United States, about 3.1%.

  • Germany, about 1.1%.

  • Japan, less than 0.25%.

Even Chinese bond yields, which used to be higher than those in the United States, have recently fallen below Treasuries.

“The past two years of synchronized global easing have given way to rapid central bank policy divergence, fostering currency market volatility” and pushing the dollar higher, Morgan Stanley Wealth Management said in a note to clients on Monday. .

The rise of the dollar has had significant effects on the global economy. On the one hand, this contributed to the increase in the US trade deficit, which reached a new high in March. A more valuable currency makes imports cheaper and exports more expensive and less competitive in world markets.

On the other hand, it reduces inflationary pressures in the United States.

“America is a nation of consumers, and more than half of what Americans consume each year is made overseas,” said David Rosenberg, chief economist at his own firm, Rosenberg Research in Toronto, in an interview. “As the dollar goes up, the cost of these imported goods goes down. These falling costs will show up in the consumer price index. We have not yet seen the full weight of it. »

Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management, said the rising dollar has dampened some of the inflationary effects in the United States from rising commodities like oil, which are priced in dollars.

“It’s unusual for the dollar to strengthen at the same time as commodity prices rise,” largely due to Russia’s war in Ukraine, she said.

But if the Fed were to decide the economy was too weak to resist rising interest rates and “take your foot off the brakes and not tighten monetary policy as fast as everyone thinks,” he said. she said, “then the dollar would weaken and we still have high commodity inflation, and we could get stuck in real stagflation. That’s, she added, “the reason why c This is a particularly dangerous time for the economy.”

Mr. Rosenberg said that by raising interest rates sharply when the dollar was already helping to lower inflation, the Fed could drag the economy into a recession. Fed Chairman Jerome H. Powell told a press conference Wednesday that inflation was too high for the Fed to hold.

“I think we have a good chance of restoring price stability without a recession,” Powell said.

The rising dollar is making life difficult for many global businesses. In addition to supply chain disruptions and inflation, they have to worry about the effect of the rising dollar on their profits. It’s earnings season on Wall Street, and this theme has come up again and again.

The dollar is hurting Apple’s revenue this quarter, Luca Maestri, the company’s chief financial officer, told analysts. “On the currency side,” he said, “we expect it to be a nearly 300 basis point headwind for our year-over-year growth rate. ” This means a negative effect of 3%.

In a similar vein, Andre Schulten, Chief Financial Officer of Procter & Gamble, said: “We have seen a new stage in cost pressure, and exchange rates have moved against us again.” The dollar’s losses are likely “to be a $300 million headwind after taxes on profits for the year,” he said.

These foreign exchange losses are passed on to the stock market.

A 2018 study by S&P Dow Jones Indices found that S&P 500 companies less dependent on foreign revenue tended to perform well when the dollar strengthened. It seems to be happening now.

A sub-index of the S&P 500 – the S&P 500 US Revenue Exposure Index, filled with nationally focused companies like Berkshire Hathaway, UnitedHealth Group, Home Depot and JPMorgan Chase – has fallen 6.2% this year through Thursday. That’s an extraordinary performance when you compare the index to its more international counterpart, the S&P 500 Foreign Income Exposure Index, which lost 15.7%. The main constituents of the foreign index are Apple, Microsoft, Alphabet and Tesla.

Although it is dangerous to make large and direct bets on the dollar, it is possible to do so through exchange-traded funds. The bull fund Invesco DB US Dollar Index, for example, has gained 8.1% this year. That compares to losses of 13% for the S&P 500 and 11.1% for the Bloomberg US Aggregate Bond Index, a popular benchmark for bonds.

But before drawing practical conclusions from this comparison, remember that the dollar will not rise indefinitely. In fact, it might make more sense to bet in the opposite direction, Ms. Shalett suggested.

Investing in companies with international exposure and investing in markets that have been battered, like Japan, can be a good contrarian move if you have a lot of patience and courage, she said. Likewise, stocks and bonds in many emerging markets, which have been hit hard by the pandemic and the war in Ukraine, are becoming attractively priced.

Chinese stocks and bonds can also be good opportunities. “I suspect that when China emerges from these Covid lockdowns and its economy really starts to pick up again, it will drag other emerging market economies with it,” Ms Shalett said. “It could be when the dollar weakens.”

Or maybe not. US Treasury secretaries typically say they favor a strong dollar, even when economic conditions don’t warrant it, as I observed in 2015, during another bout of dollar strength.

Like this, it happened largely because monetary policies in the United States were out of sync with those of other major countries. As a side effect, American travelers got a little more for their money, but American exporters suffered.

The dollar’s victory lap didn’t last long. This one probably won’t either.

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