US Dollars, please

Stocks slumped for a fifth straight session as fear-gripped traders contemplate a global economic downturn. Bond yields spiked higher yesterday adding pressure to equities.

Pounded. I am going to start with your chart of the day. You already probably know what it is going to be based on my one-word tagline. Really, it doesn’t matter whether you know or not, because just looking at the chart, which covers the years from 1970 through current tells you all that you really need to know. So here it is, enjoy it for 30 seconds or so then continue reading.

Ok, so now you are thinking, “if that is a stock, I don’t want to own it!” Well, you may already know by now that the chart is of the British Pound Sterling versus the US Dollar, and what you are witnessing is that the Pound is now at its lowest since at least 1970. Another way to look at it is that the US Dollar is at its strongest since at least 1970. The Pound has been particularly hit hard as its newly elected administration has moved to cut taxes and spend more, which is a form of fiscal easing, while its central bank is tightening monetary policy to fight inflation (just like most other developed economies except for Japan). Remember that international money tends to flow toward countries with the highest sovereign debt yields. The currency conversion in those countries props up the countries’ currencies. For the US Dollar, propped up by an uber-hawkish Fed and rising sovereign debt yields, gains are accentuated because the Dollar is considered a safe-haven currency which is sought after when the global economy is bumpy – which it is – and when geopolitical risk is high… which it is. That is good news if you have a kid or a grandkid studying abroad… particularly in London where an order of fish and chips may be higher due to inflation, but cheaper if that kid started out with Dollars and converted them to Pounds.

I have made mention of the strong dollar time and again and most recently highlighted its rise against the Dollar Index which tracks the US Dollar against a basket of major trade partner currencies. While the Dollar Index (DXY, as it is sometimes referred to) is not at an all-time high, it is at a 20-year peak, and that says something. Yes, it is true that a strong Dollar is desirable when traveling abroad and buying foreign goods, but the reverse is not so good as US produced goods and services become more expensive to foreign buyers. That is why, under more normal circumstances, you may hear political leaders hoping for a weaker currency, because it is typically an economic growth driver. In today’s economy, however, the implications of a strong currency are less desirable. The Eurozone is on the brink of recession suffering from not only a similar rise in inflation but also from an energy squeeze caused by the war in Ukraine. To put a finer point on it, a group of top economists put the probability for a Eurozone recession (within 1 year) at 72.5% while that same group puts a US Recession at a 50% probability. That means that US companies who rely on European customers now have to deal with the possibility of weaker sales numbers. COMPOUNDING that problem is the fact that US goods will cost foreign customers more, AND companies will lose more profit repatriating cash received from foreign sales because of the strong Dollar. As if there were no existing challenges selling goods and services domestically, companies are surely feeling, if not expecting to feel some pressure on their profits. That reality is certainly making its way into the minds of already shell-shocked stock investors, adding more volatility to an already volatile market.

Later this week we will get a read on the state of inflation in Friday’s PCE Deflator release. Next week, we will get monthly employment numbers, and the week after, more inflation news in the Consumer Price Index / CPI. Before you can take a breath, Q3 earnings season will ramp up in mid-October. Clearly, the Fed will be watching the economic releases closely, but Fed members will also be watching earnings season as well. More than just beating or missing earnings targets, companies will provide commentary and guidance. Those are likely to include gripes about not only increased borrowing costs, revenue headwinds, and supply chain challenges, but also about currency challenges. Some will even quantify the increased costs associated with the raging Dollar. The Fed will meet again on November 2^nd and probabilities favor a +50 basis-point hike with a 76% chance of a bigger +75 basis-point bump. Numbers that are likely to change a lot – in both directions – over the next few weeks.

YESTERDAY’S MARKETS

Stocks slumped further yesterday, and the Dow slipped into bear territory as investors feared a global economic downturn. The S&P500 dropped by -1.03%, the Dow Jones Industrial Average sank by -1.11%, the Nasdaq Composite Index slipped by -0.60%, and the Russell 2000 Index declined by -1.41%. Bonds declined and 10-year Treasury Note yields gained +23 basis points to 3.92%. Cryptos gained +2.41% and Bitcoin advanced by +1.11%.

NEXT UP

• Durable Goods Orders (August) are expected to have slipped by -0.3% after a -0.1% decline in July.
• FHFA House Price Index (July) is expected to come in flat after growing by +0.1% in the prior period.
• Conference Board Consumer Confidence (August) may have risen to 104.5 from 103.2.
• New Home Sales (August) are expected to have declined by -2.2% after falling by -12.6% in the prior month.
• Fed speakers today: Evans, Daly, Bullard, and Kashkari. Chari Powell will also speak on a panel on cryptos.