The Strong Dollar Is a Problem for Stocks

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Image source: QuinceCreative / Pixabay

The US dollar is the world’s reserve currency as it is the means of exchange for the leading economy. Moreover, the dollar is freely convertible, and the world has embraced political stability in the United States. Central banks, governments and monetary authorities hold reserves in currencies and gold. The US dollar has long been the foreign exchange instrument of choice for cross-border trade agreements because of its status as the leading reserve instrument.

US administrations have typically embraced a strong dollar policy. Under President Trump, however, the dollar became a trade tool for negotiating with partners worldwide. A lower dollar favors US companies, making them more competitive on the global landscape. Conversely, a strong dollar often weighs on revenues and earnings of US multinational companies as US goods become more expensive in other currency terms.

The dollar has been on a bullish path since early 2021 when the Biden Administration took over. The bull market in the US currency is one of many factors that weighed on the US stock market in 2022.

The dollar index measures the dollar against other reserve currencies

  • The dollar index measures the dollar against the euro, British pound, Japanese yen, Canadian dollar, Swedish krona, and Swiss franc.
  • The index has a 57.6% exposure to the euro.
  • A weak dollar tends to support profits for US multinational companies, making products less expensive abroad.
  • A strong dollar causes US exports to become more costly in other currency terms, weighing on US multinational corporate earnings.

The dollar index is trending higher and at the highest level in two decades. Interest rate differentials are the key

  • The dollar index reached a low of 89.165 in early January 2021.
  • The index has made higher lows and higher highs over the past nineteen months, reaching 109.14 in July, the highest level since 2002.
  • Rising US interest rates supported gains in the dollar index- Interest rate differentials are a critical factor for the value of one currency versus another.

The euro is the second leading reserve currency

  • The euro is a reserve currency second only to the dollar regarding trade and central bank holdings.
  • The euro currency declined to a two-decade low when it traded at parity against the dollar in July 2022.
  • The war on Europe’s doorstep and rising geopolitical tensions have weighed on the euro.
  • US interest rates are higher than European interest rates, supporting the dollar versus the euro foreign currency relationship.

Technical resistance for the dollar index is far above the current level

  • The dollar index rose above the first technical resistance level at the 103.96 March 2020 high.
  • The next upside targets are the 2002 120.800 high and the 2001 121.290 peak.
  • The path of least resistance of the dollar index remains higher at over the 106 level on July 29.
  • Currency volatility tends to be low because governments intervene in the foreign exchange market to provide the stability that supports trade, making trends slow and steady.

Rising rates and a strong dollar are typically a bearish cocktail for the stock market. The upward trajectory has run out of steam since mid-July

  • Increasing interest rates cause capital to flow from stocks to fixed-income assets.
  • A strong dollar often weighs on earnings for US multinational companies.
  • The leading stock market indices have made lower highs and lower lows over the past months.
  • Keep an eye on the US Fed and interest rate policies over the coming months for clues about the stock market’s path of least resistance.
  • The Q2 GDP data showing the US economy contracted for the second consecutive quarter could slow down future interest rate hikes, weigh on the dollar index, and foster a recovery in the stock market.
  • The dollar index has been making lower highs and lower lows since July 14 and settled below the 106 level on July 29, the lowest level since early July. Stocks have recovered as the dollar declined.

Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!

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Equities News Contributor: Tradier Inc.

Source: Equities News

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