A stronger dollar is a problem for U.S. stocks because it reduces what companies rake in when foreign sales are translated back into greenbacks.
Mark Wilson/Getty Images
The
dollar
has risen lately to a key level. And If it breaks above that, the stock market could drop.
The
U.S. Dollar Index
(DXY), which measures the buck against a basket of currencies, is up just over 5% from a mid-July low point to 105. The main driver has been higher yields on U.S. government bonds as the rate of inflation hasn’t been declining much in the past couple of months. That attracts buyers of dollars who are looking to own U.S. bonds.
A stronger dollar is a problem for U.S. stocks because it reduces what companies rake in when foreign sales are translated back into greenbacks. It’s also reflective of a safe-haven trade, since the dollar is the global reserve currency, one that comes as economies around the globe suffer, something that can also pressure U.S. stocks.
So far, the higher dollar hasn’t really bothered the domestic equities. There are many reasons that the
S&P 500 index
is down about 1.5% since mid-July, but chief among them is profit-taking, as double-digit-percentage gains in the index so far this year have incentivized investors to sell, especially in the face of one key risk. The delayed damage to the economy from higher interest rates, which are meant to squelch inflation, is likely still rolling though the economy.
Another indication that the stronger dollar hasn’t much harmed the market yet is seen in stocks of companies vulnerable to a stronger dollar.
Caterpillar
(ticker: CAT) and
Micron Technology
(MU) derive about 60% and 50%, respectively, of their sales outside the U.S., and yet the shares of those companies are up 16% and 13%, respectively, since the dollar began its ascent.
This ease that investors have about the dollar, for the moment, is because the buck hasn’t truly “broken out” yet. The dollar index has seen sellers come in to knock it lower at around 105 several times since late 2022. Until the index breaks above this level, it will look as if the dollar will remain below recent peaks.
But with the dollar so close to breaking out, the S&P 500 and dollar-exposed stocks alike are indeed vulnerable. If the dollar index were to break above 105, it would mean there weren’t many sellers, and buying pressure could send the index back to the 112 multidecade high set in October 2022. Even if it doesn’t reach the mark, a more-expensive dollar could be a burden.
“If the dollar surges, that will start to become a headwind on stocks,” wrote Sevens Report’s Tom Essaye.
Dollar gains are certainly plausible if the gap between U.S. and foreign-bond yields widens to make U.S. bonds more attractive. Currently, the 10-year Treasury yield is just over 4%, while the German bund yield is at just over 2.7%. If Germany’s economy weakens—it may be near recession territory—the 10-year bund yield may drop, sending money into U.S. bonds and the dollar. Economic weakness in other countries could also send investors seeking stability in their portfolios into the dollar.
An even-higher dollar lurks in the weeds as a risk to stocks. Monitor the buck.
Write to Jacob Sonenshine at [email protected]
Read the full article here