Dollar strength gives Wall Street something new to worry about3 min read . Updated: 04 Oct 2021, 05:42 PM IST
- Concerns about growth and surging energy prices, as well as higher bond yields, attract investors to greenback
Listen to this article
The dollar has been on a tear of late, propelled by deepening jitters about global growth and rising U.S. bond yields.
The WSJ Dollar Index hit the highest point since September 2020 in recent days. The gauge, which measures the greenback against a basket of currencies, has marched steadily higher since June, adding nearly 2% over the past month.
A strong dollar has the potential to hold back gains in stocks and other risky investments. Companies in the S&P 500 generate 40% of their revenue from outside the U.S., according to FactSet. When the dollar strengthens, the value of money earned abroad shrinks. Emerging-market companies and countries also tend to suffer because their large dollar-denominated debts become harder to pay off.
“A stronger dollar can be a bit of a wrecking ball. Broadly, it’s a tightening of global financial conditions," said James Athey, an investment manager at Aberdeen Standard Investments.
Driving the greenback higher has been expectations that the Federal Reserve will act earlier and more aggressively to remove pandemic-era stimulus. Supply-chain snarls, soaring energy prices and disrupted industrial activity in markets including China and the U.K. have also weighed on growth prospects.
The world’s reserve currency tends to perform well in two scenarios: When the global economy is doing badly, as investors shelter in safe-haven assets, and when the U.S. economy is doing well compared with others, prompting investors to snap up dollar-denominated investments. This is called the dollar smile, as it rises in these two instances and flattens in between.
Right now, there are elements of both ends of the smile driving investors into the dollar.
“Markets are more cautious and nervous over the risk of a further slowdown," said Lee Hardman, a currency analyst at Japanese bank Mitsubishi UFJ Financial Group. He worries that the surge in energy prices globally will hit consumers and businesses, while also raising concerns about inflation.
Meantime, the world’s major central banks are signaling intent to cut back on stimulus, sending bond yields higher. Federal Reserve Chair Jerome Powell said in late September that the central bank would likely announce the start of its tapering program at its next meeting in November. Fed policy makers are also increasingly signaling expectations that interest rates could rise as soon as next year.
U.S. government bonds of nearly all maturities have sold off as investors prepare for a reduction in the Fed’s colossal presence in markets. The yield on the benchmark 10-year Treasury note climbed last Monday above 1.5% for the first time since June, and stayed above the threshold for much of the week. It edged down moderately Friday to close at 1.464%, before climbing again to 1.493%. Yields rise when prices fall.
The uptick is attracting investors seeking to lock in higher yields, pushing up demand for the dollar.
“Would you rather own a German bund with a yield around minus 0.3% or own a Treasury denominated in the world’s reserve currency that yields 1.5%?" Mr. Athey said. “It’s a no-brainer." Last week, he bought more 10-year Treasury notes.
German government bond yields have also ticked up, but at a slower pace than Treasurys. The euro weakened 1% against the dollar last week.
While the European Central Bank has put forward plans to begin curbing its emergency pandemic stimulus measures, most investors aren’t expecting a substantial shift in policy soon, in contrast with the Fed.
Georgina Taylor, a multiasset fund manager at Invesco, has been increasing her exposure to the dollar for several weeks, in a defensive play. She recently sold euros against the dollar and also dumped some stocks to reduce her overall risk level.
Regarding U.S. Treasurys, “We’re quite happy to have some exposure there, particularly relative to other bond markets around the world," Ms. Taylor said.
If the dollar stays strong, it may eventually contribute to its own weakening, analysts said. Many global commodities such as oil and copper are priced in dollars, so a stronger greenback makes them more expensive and weighs on demand. Lower demand may lead to a slide in prices, letting some air out of inflationary pressures.
This story has been published from a wire agency feed without modifications to the text
Never miss a story! Stay connected and informed with Mint. Download our App Now!!