Analysis-Rebounding U.S. dollar a growing headache for investors
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[March 01, 2023] By
Saqib Iqbal Ahmed
NEW YORK (Reuters) - Investors reeling from the recent volatility in
global financial markets are eyeing another potential worry: a
rebounding dollar.
The dollar has risen nearly 4% from its recent lows and stands near a
seven-week high against a basket of other major currencies, driven by
bets the Federal Reserve will need to raise rates higher than many
investors had previously forecast to cool inflation.
The U.S. currency remains some 8% below the twenty-year high it attained
last year. Yet its rebound, along with a surge in Treasury yields, has
already complicated the outlook for a range of trades that prospered as
the dollar tumbled in the latter half of 2022.
MSCI’s index for emerging market stocks has slipped 8% from its January
highs, while the MSCI Emerging Markets Currency Index is down 3% from
its early February high.
A rally in European stocks has also stalled, with the Stoxx Europe 600
Index nearly flat for the last three weeks after having gained about 20%
since late September. Gold, meanwhile, is trading flat on the year after
having given up a 7% gain.
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"A stronger dollar poses a problem for risk assets," said Lauren
Goodwin, economist and portfolio strategist at New York Life
Investments.
Because of the dollar's central role in the global financial system, its
fluctuations have widespread repercussions.
A stronger dollar tends to tighten global financial conditions while
diminishing appetite for risk-taking and weakening global trade, the
Bank for International Settlements said in a report in November. It also
makes it more difficult for countries that borrowed in the U.S. currency
to service their debt, a problem often acutely felt by emerging market
economies.
"The tailwind behind foreign currencies from a more dovish Fed is
generally off the table," said Eric Leve, chief investment officer at
wealth and investment management firm Bailard.
A stronger dollar also makes crude oil, gold and other
dollar-denominated commodities more expensive to foreign buyers. Part of
the 2% year-to-date decline in Brent crude can be traced to the dollar’s
rebound, analysts at UBS Global Wealth Management wrote in late
February. They expect China's reopening and Russian supply disruptions
to override the U.S. currency's influence and boost oil later in the
year.
For the U.S., dollar strength makes exports less competitive while
weighing on the bottom lines of multinational companies by making it
more expensive for them to convert foreign earnings into their own
currency.
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A picture illustration shows U.S.
100-dollar bank notes taken in Tokyo August 2, 2011. REUTERS/Yuriko
Nakao/File Photo
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Morgan Stanley analysts led by chief U.S. equity strategist Michael
Wilson on Monday wrote that the dollar's directions could be a key
factor for the near term trajectory of U.S. stocks, citing the
currency’s relationship to global liquidity conditions. The S&P 500
index is down nearly 5% from its recent highs and holding onto a
3.6% year-to-date gain.
"If rates and the U.S. dollar continue higher we think these key
support levels for stocks will quickly give way as the bear (market)
resumes more forcefully," they wrote.
Whether the dollar continues its rebound will depend in part on
investors' perceptions of how much higher the Fed will need to raise
interest rates. Some insight into policymakers’ thinking and the
economy's strength could come next week as Fed Chairman Jerome
Powell delivers his semiannual monetary policy testimony before the
Senate Banking Committee and the U.S. reports February employment
data.
Colin Graham, head of multi-asset solutions at asset manager Robeco,
believes the dollar is unlikely to rebound much further and said he
would likely initiate bets against the U.S. currency if the dollar
index rose to 106 from its current level of 104.
A move to the 114 level, the highs from September, would prompt him
to abandon his bullish view on emerging markets, he said.
Emily Leveille, portfolio manager at Thornburg Investment
Management, is also skeptical the dollar's bounce will last and
views any weakness in emerging markets as a buying opportunity.
"Emerging market currency weakness can be a great time to step in
and build positions in high-quality companies," Leveille said.
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Analysts at Capital Economics, on the other hand, believe an
expected slowdown in global growth and souring risk appetite will
send investors flocking to the dollar, a popular destination during
uncertain times, and push the currency back to its highs later this
year.
"We expect risk sentiment to deteriorate amid this weakening global
backdrop and 'safe-haven' demand to push the dollar higher over the
next couple of quarters," they wrote.
(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and
Chris Reese)
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