Market analysts said the US dollar could lose its appeal as one of the few reliable safe-haven assets in times of economic and geopolitical uncertainty after an 18-month rally, and further declines in the currency could set the stage for a 2023 stock market rally. can promote. ,
But a surge in the dollar could be a test for equity bulls in the near term.
“There has been a clear inverse correlation between equities and the US dollar over the last 12-14 months. …DXY looks very poised for a countertrend rally here, and we don’t think we can get a true sense of the durability of this rally until we see how shares react to a rising dollar,” Jonathan Krasinski , said chief market technician BTIG, in a note last week (see chart below).
The ICE US dollar index DXY, a measure of the currency against a basket of six major rivals, jumped 1.2% on Friday after an unexpectedly strong jump in US January nonfarm payrolls dented markets’ perception that the Fed’s interest rate hike The end of the rise is finally near.
Stocks fell Friday in the wake of the data, but the Nasdaq Composite Comp still posted its fifth straight weekly gain, up 3.3%, while the S&P 500 SPX gained 1.6% weekly, led by a continued rally for tech Was doing. related shares. The Dow Jones Industrial Average DJIA saw a 0.2% weekly decline.
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The dollar may be ready to bounce. The dollar index fell to a nine-month low on Wednesday after the Federal Reserve raised the fed-funds rate by 25 basis points, raised its policy interest rate for an eighth straight meeting and set for more than one hike. The signal is still planned. But markets remained at odds with forecasts for the Fed to peak above 5% and stay there, rather than cut rates before the end of the year.
While Powell continued to push against expectations of rate cuts and reiterated his earlier concern about easy financial market conditions, he also acknowledged for the first time that “the deflationary process has begun.” It was enough for traders to bet that the rate-hike cycle is nearing its end with further cuts in store soon.
The dollar rallied for most of 2022, with the index jumping 19% in the first nine months of the year and hitting a peak of 114.78 in late September, as higher interest rates in the US attracted foreign investors. A rising dollar was described as a “wrecking ball” for declining stocks. The greenback’s gains came in the form of rising Treasury yields, which made bonds more attractive relative to other income-earning assets.
Larry Adam, chief investment officer at Raymond James, said the dollar’s subsequent overvaluation and market expectations that the Fed would begin to scale back its monetary tightening cycle.
“Tailwinds that supported the US dollar in 2022 such as Fed hawkishness and favorable yield gains turn into headwinds as they move into 2023,” he added.
John Luke Tyner, portfolio manager and fixed-income analyst at Aptus Capital Advisors, said the dollar outperformed the rest of the world last year because the Federal Reserve was leading global central banks in this interest rate-hiking cycle. . Now other central banks are playing catch-up.
“Where they are on the tight schedule is behind us, and so as they continue to hold, it should help strengthen the euro versus the dollar,” Tyner said.
Both the European Central Bank and the Bank of England raised interest rates by half a percentage point on Thursday as expected in their efforts to tame inflation. While the ECB hinted at further hikes, the BOE suggested that it may soon stop.
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According to Dow Jones market data, the dollar’s strength has declined by 10% over the past four months.
“The dollar was probably overpriced based on the ridiculous expectations the Fed would hike to 6% — where you saw some people getting really giddy in those expectations,” Tyner told MarketWatch on Thursday.
However, while Powell and his allies are determined to keep interest rates high “for some time,” investors still do not believe they will stick with higher rate hikes into 2023. Traders forecast a 52% chance the rate will peak at 5-5.25% by May or June, followed by a cut of about 50 basis points by the end of the year, according to the CME’s Fedwatch tool.
As a result, market analysts believe the dollar is nearing its end and is likely to fall further in 2023 as inflation cools and recession risks recede.
Gene Frieda, global strategist at Pacific Investment Management Co. or PIMCO, said gains for the dollar will be capped against other developed economies as the Fed moves toward an expected pause in its hiking cycle in the first quarter of 2023.
Frieda and his team said in a note earlier this week that the dollar’s strength in 2022 was in part due to the substantial risk premium charged on European assets for tail risks that could lead to Russian energy supply cuts , or worse, a “nuclear incident”. A risk premium is the extra return an investor seeks for holding a risky asset over a risk-free asset.
Frieda acknowledged the possibility that inflation could prove stagnant in the US compared to other advanced economies, or that monetary policy could become tighter for an extended period. This suggests that risk premiums in the dollar market may remain large, but “these premiums may decline further as shocks subside and evidence builds that last year’s increase in inflation is well and truly improving.” And it’s getting smaller.”
“We expect the dollar to continue to lose its appeal as a safe-haven currency of last resort,” Frieda said.
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However, it’s not all bad news. The decline in the greenback could catalyze rallies in riskier assets such as stocks, which have closed the new year on a bright note.
As of Friday, the dollar index had fallen more than 10% since Sept. 27, when it hit a two-decade high, while the S&P 500, the large-cap index for the stock market, has gained more than 11%.
At the dollar’s 2022 high, the DXY was up 19% for the year, according to Dow Jones market data, while the S&P 500 declined 22%.
Meanwhile, some analysts caution against using the recent inverse correlation between the dollar and stocks to jump equities back into other riskier assets.
“It may be that investors are taking this announcement from the Fed, and their current sentiment, to mean they may move back into riskier assets, but I wouldn’t say,” said Shelby McFadin, senior analyst at The Motley Fool. That it’s a guarantee.” asset Management.
“Certainly we can say correlation, not causation … You can say it’s a sign, but not that it’s suggestive,” McFadin said.
Source: www.marketwatch.com
