Dollar strength gives Wall Street something new to worry about

The WSJ Dollar Index rose to its highest point since September 2020 in recent days. The gauge, which measures the greenback against a basket of currencies, has risen steadily higher since June, up about 2% over the past month.

A strong dollar has the potential to reap profits in stocks and other risky investments. According to FactSet, companies in the S&P 500 generate 40% of their revenue from outside the US. When the dollar strengthens, the value of money earned abroad decreases. Emerging market companies and countries also suffer as their big dollar debt becomes harder to pay off.

“A strong dollar can be a bit of a wrecking ball. Broadly speaking, it is a tightening of global financial conditions,” said James Athe, an investment manager at Aberdeen Standard Investments.

Taking the greenback higher is expected to prompt the Federal Reserve to act earlier and more aggressively to remove pandemic-era stimulus. Supply-chain disruptions, rising energy prices and disrupted industrial activity in markets including China and the UK have also affected growth prospects.

The world’s reserve currency tends to perform well in two scenarios: when the global economy is doing badly, as investors seek shelter in safe-haven assets, and when the US economy is performing well compared to others, investors should look to the dollar. Valuable investments are prompted to close. . It is called the dollar smile because it rises up and flattens in the middle in these two examples.

Right now, there are elements of both ends of the smile that are driving investors to the dollar.

“Markets are more cautious and nervous about the risk of a further downturn,” said Lee Hardman, a currency analyst at Japanese bank Mitsubishi UFJ Financial Group. He worries that rising energy prices will affect consumers and businesses globally, while also raising concerns about inflation.

Meanwhile, the world’s major central banks are signaling their intention to cut back on stimulus, which should push bond yields higher. Federal Reserve Chairman Jerome Powell said in late September that the central bank could announce the start of its tapering program at its next meeting in November. Fed policymakers are also increasingly signaling expectations that interest rates could rise as soon as next year.

Nearly all maturity U.S. government bonds have sold out as investors prepare for a reduction in the Fed’s heavy presence in the markets. The yield on the benchmark 10-year Treasury note climbed above 1.5% last Monday for the first time since June, and remained above the threshold for much of the week. It closed down marginally at 1.464% on Friday, before climbing again to 1.493%. Yields increase when prices fall.

That’s attracting investors seeking to lock in higher returns, pushing demand for the dollar.

“Would you rather own a German bundle with a yield of minus 0.3% or own a Treasury denominated in the world’s reserve currency that yields 1.5%?” Mr Athe said. “It’s a no brainer.” Last week, he bought more 10-year Treasury notes.

German government bond yields have also risen, but at a slower rate than that of the Treasury. The euro weakened 1% against the dollar last week.

While the European Central Bank has put forward plans to curb its emergency pandemic stimulus measures, most investors are not expecting a substantial change in policy anytime soon, unlike the Fed.

Georgina Taylor, a multiset fund manager at Invesco, has been increasing her investment in dollars for several weeks in a defensive play. It recently sold the euro against the dollar and dropped some stocks to reduce its overall risk level.

Regarding the US Treasury, “we are very pleased to have some exposure there, particularly relative to other bond markets around the world,” Ms Taylor said.

Analysts said that if the dollar remains strong, it could ultimately contribute to its own weakening. Many global commodities such as oil and copper are priced in dollars, so a strong greenback makes them more expensive and weighs on demand. Lower demand could push prices down, allowing some wind from inflationary pressures.

This story has been published without modification to the text from a wire agency feed