The recent surge in the value of the U.S. dollar has caught the attention of investors, as it approaches a crucial level. Should the dollar break through this level, it could spell trouble for the stock market.
The U.S. Dollar Index (DXY), which measures the strength of the dollar against a basket of currencies, has experienced a remarkable 5% increase since its mid-July low, reaching a value of 105. This upward trajectory can be attributed to higher yields on U.S. government bonds, as inflation rates have remained relatively stable in recent months. Consequently, investors seeking to invest in these bonds have been drawn to the allure of the dollar.
However, while the surging dollar may seem like good news for the U.S. economy at first glance, it actually presents challenges for American companies. A stronger dollar translates to reduced profits when foreign sales are converted back into dollars. Additionally, it reflects a global economic downturn, wherein the dollar serves as a safe-haven currency. Such economic hardships around the world can exert further pressure on U.S. stocks.
Remarkably, the impact of the stronger dollar on domestic equities has been minimal thus far. Although the S&P 500 index has declined around 1.5% since mid-July, this dip can be attributed primarily to profit-taking. The index has experienced substantial gains this year, motivating investors to cash in on their investments. Furthermore, one key risk looms over the market – the delayed repercussions of higher interest rates intended to curb inflation. This impact is yet to fully materialize within the economy.
An interesting observation can be made when examining companies vulnerable to a stronger dollar. Despite having a significant portion of their sales generated outside the United States, giants like Caterpillar (ticker: CAT) and Micron Technology (MU) have experienced impressive stock price increases of 16% and 13%, respectively, since the dollar’s ascent began.
Overall, while the dollar’s ascent has yet to significantly disrupt the market, it remains a critical factor to monitor. Its potential to adversely affect profitability and reflect global economic challenges cannot be overlooked. Investors should remain vigilant and prepared for potential shifts in the stock market as the dollar continues its upward trend.
The Dollar’s Potential Impact on Stocks
Investors are currently at ease with the dollar due to its lack of a significant breakout. Since late 2022, the dollar index has experienced multiple instances of sellers pushing it lower around the 105 level. Until the index surpasses this resistance, it is likely that the dollar will remain below recent peaks.
However, the dollar is on the cusp of a potential breakout, and both the S&P 500 and dollar-exposed stocks are susceptible to its impact. A breakout above the 105 level would signify a scarcity of sellers, potentially leading to a resurgence towards the October 2022 multidecade high of 112. Even if it falls short of that mark, a stronger dollar could still pose a burden.
In a scenario where the dollar surges, it may become a headwind for stocks. Tom Essaye, of Sevens Report, points out that the dollar’s strength could hinder stock performance.
The possibility of dollar gains arises if the yield gap between U.S. and foreign bonds widens, making U.S. bonds more appealing. Presently, the 10-year Treasury yield stands slightly above 4%, while the German bund yield rests a little over 2.7%. Should Germany’s economy weaken, potentially nearing recession territory, the 10-year bund yield might decrease, prompting capital flow into U.S. bonds and the dollar. Economic weaknesses in other countries could also drive investors to seek stability by investing in the dollar.
Another risk to stocks lies in the potential for an even stronger dollar. It is essential to monitor the dollar’s movements closely.