The U.S. Dollar Strengthens as Investor Concerns Mount

The U.S. dollar continued its upward trajectory, bolstered by rising Treasury yields and growing apprehension among investors about prolonged higher interest rates. This trend poses challenges for the stock market.

U.S. Dollar Index
The U.S. Dollar Index, a gauge of the currency's performance against a basket of six major counterparts, experienced a more than 0.2% increase on Tuesday, surpassing 106.2. However, it later settled slightly lower around the 106 level. Over the past five days, the index has gained 0.8% and is now up over 6% from its July lows. These figures mark its highest level since November 2022.

WSJ Dollar Index
Similarly, the WSJ Dollar Index, which measures the greenback against a broader basket of 16 currencies, recorded a 0.1% rise on Tuesday, marking its sixth consecutive day of increases.

Although the dollar currently falls below its peak from 11 months ago (October 2022), where it reached its strongest position in two decades, its rapid ascent in recent weeks has raised concerns among investors. This development carries significant implications for the stock market.

Following the Federal Reserve's latest monetary policy decision on September 20, stocks have experienced declines while bond yields and the dollar have surged. Despite holding interest rates steady, the Fed signaled that borrowing costs might need to rise further to adequately curb inflation. According to Fed officials, interest rates could remain above 5% until 2024.

Raffi Boyadjian, an analyst at broker XM, noted that "investors are shifting away from government securities and allocating more funds towards cash in anticipation of potential further rate hikes in the United States." Indeed, when interest rates rise or are expected to rise, bond yields also increase. Consequently, investors find moving their funds into the U.S. currency more appealing, as it provides relatively higher risk-free returns on government debt.

The yield on the benchmark 10-year U.S. Treasury experienced a surge, surpassing 4.5% from 4.36% prior to the Federal Reserve's meeting last week. Currently, it trades at levels not witnessed since 2007.

The Impact of Higher Bond Yields on Stocks

In recent times, higher bond yields have become a cause for concern in the stock market. This is because investors are less likely to invest in risky assets like equities when they can earn higher returns from safe Treasury bonds. However, the consequences of elevated yields go beyond just decreased investor interest.

One major consequence is the strengthening of the US dollar relative to other currencies. When the greenback is strong, it negatively impacts multinational companies that generate profits in foreign currencies. This is particularly relevant for companies listed on the S&P 500 index.

The rise in bond yields and the subsequent surge of the dollar can be attributed to more than just Treasury yields. Global economic conditions also play a significant role. Various economies around the world, such as China and Germany, are facing challenges like a potential property crisis and a risk of recession respectively. These adversities have had an adverse effect on rival currencies.

The increasing strength of the dollar is considered a potential headwind for the stock market. The greenback recently surpassed the 105 mark and is now at 106. According to Boyadjian, a financial expert, the dollar's momentum seems unstoppable.

Investors should closely monitor the release of the core personal-consumption expenditures (PCE) index data on Friday. This index is the preferred measure of inflation by the Federal Reserve. It has the potential to significantly impact rate expectations, bond yields, and consequently, the value of the dollar.

Boyadjian anticipates that Friday's release of the core PCE price index will provide valuable insights. If the forecasted drop to 3.9% in August holds true, there may be a temporary pause in the rally of bond yields and the advance of the US dollar.

Tune in for updates on the inflation front and its impact on bond yields and the US dollar.

Written by Jack Denton