A weakening stock market is not going to be saved by a strong dollar this time. Yes, Europe and Japan and the U.K. have low yield and a much more dire economic outlook for the time being, but it is unlikely that asset managers there will be throwing money into the U.S. stock market for much longer. There is no near-term bottom yet.
“What’s the pain point for the Fed here? We are at 3659 in the S&P 500 and we think it could go to 2800, though I don’t want to be too dour,” says Vladimir Signorelli, head of Bretton Woods Research, a macro investment-themed research firm. “Another 20% fall is certainly in the realm,” he says.
With currencies weaker in the other core economies, it becomes more costly for these foreign asset managers to buy dollars.
Still, where else are they going to get 4% on a one-year T-bill? Parking money in Treasurys will still be seen by them as a safe investment. But that won’t really help the stock market unless there is a pivot from Jerome Powell at the Fed. Equities hate rising interest rates. The consensus in the Beltway now is that recession is the best way to fight inflation, and that is what America is getting.
The strong dollar—or, more precisely, a rapidly fluctuating dollar—is a growing economic threat, WSJ editorial writers said on Thursday.
“For now it may help the Fed tamp down inflation by reducing the dollar prices Americans pay for imports, especially energy. But American companies will soon find the dollar values of their foreign profits shrinking. Meanwhile, weak currencies exacerbate inflation in America’s most important trading partners,” the WSJ Editorial Board wrote. “If you think the eurozone’s energy crisis is bad now, see what happens the longer they need to import energy with a euro worth 99 cents.”
The U.S. is in better shape than Europe. But the Atlanta Fed GDP tracker has cut its third quarter GDP forecast to just 0.3%, down from an earlier forecast of 2% mid-summer. The economy is getting weaker. The strong dollar has done nothing for the U.S. economy.
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“The rampaging dollar is a negative for global risk assets, including those in the U.S.,” says Brian McCarthy, head of Macrolens. “It puts tremendous pressure on dollar debtors around the world, particularly those in emerging markets. The Fed is on a path that leads eventually to a credit crisis. It’s taking a while because we’ve come out of the pandemic at very high levels of nominal growth. But the interest rate path they laid out at Wednesday’s meeting is a surefire recipe for global financial stress,” he says. His Friday note to clients says it all: “The Coming Crash.”
Interest rate hikes from the Fed are making the dollar “a wrecking ball,” says Brendan Ahern, CIO of KraneShares. Higher U.S. interest rates mean countries like Japan and those in Europe are enticed to buy U.S. bonds, which surely pay more than the barely 1.5% one gets in Europe. This pulls money out of global equities and into Treasuries, or cash.
Over the last three months, emerging market investments have lost more than $10 billion in redemptions. Europe-focused funds are way worse. They have lost nearly $40 billion. Meanwhile, U.S. equity funds have seen $15 billion in inflows, some of this due to inflows from Europe.
But how long can that last? Nearly everyone on Wall Street is now betting on recession. Last week, Vanguard gave recession odds upwards of 60%.
“Equity sentiment is weak, and already appears to be pricing an earnings slowdow,” says Mark Haefele, CIO of UBS Global Wealth Management. “We remain invested, but are selective. Focus on defense, income, value…and security.”
Crude oil markets also pricing in a slower economy, down 5.5% on Friday just before the close. U.S. automakers, Ford, GM and Tesla TSLA are all down over 4.5% on the expectation that soon-to-be-laid-off Americans won’t be buying the Ford Lightning EV anytime soon. Even emerging markets are doing better than them. The iShare MSCI Emerging Markets ( EEM ) ETF is down just over 2.6%.
Meanwhile, dollar futures are up 1.6%, suggesting there is no end in sight to the dollar rally.