US stocks rally could falter in face of strong dollar, warn analysts

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US stocks have risen in tandem with the dollar this year, in a break with historical trends that has led some analysts to question how much longer the rally can withstand the greenback’s strength.

The dollar has climbed 4.7 per cent against a basket of six peer currencies this year, while in the same period Wall Street’s benchmark S&P 500 has added 7 per cent.

“If the dollar continues to trend higher, equities will struggle,” said Mislav Matejka, head of global equity strategy at JPMorgan. “Historically, equities and the dollar exhibited a strong inverse correlation.”

The dollar’s rise — driven by the Federal Reserve’s rate increases — was one of the factors weighing on stocks in 2022, according to strategists. The dollar index gained 8 per cent that year, while the S&P 500 shed almost one-fifth of its value, the biggest annual drop since the global financial crisis in 2008.

When the dollar is strong, US companies’ overseas sales convert into fewer dollars, offering smaller profits and a potential hit to earnings and valuations.

However, equities have been better able to “digest” the greenback’s rise this year because “the pace of the dollar strength is not as stark as 2022”, said Karim Chedid, head of investment strategy for iShares Emea at BlackRock.

He also noted that most major central banks, including the Fed, appeared to be moving from a tightening to an easing cycle, in contrast to 2022, with any US rate cuts likely to weigh on the dollar. “We’re at the peak of the rate cycle. Yes, the expectations have been pushed back, but we’re still expecting the rate-cutting cycle to begin.”

Stocks have continued to rally this year even as traders have rapidly scaled back lofty expectations for US rate cuts. Swaps markets are fully pricing in just one quarter-point interest rate cut in the US by the end of 2024; at the end of the 2023 they were expecting more than six.

Indeed, equities and the dollar appear, unusually, to have been moving in response to the same driver in recent months, according to Binky Chadha, chief global strategist at Deutsche Bank.

“Better US growth means better prospects for US earnings and equities [but] it also means higher US rates — fewer interest rate cuts — and a stronger dollar, as growth elsewhere has been lacklustre,” said Chadha.

Some strategists warn, however, that the equity rally may not be able to withstand the dollar’s strength for much longer.

“Earnings are quite decent — for now — but if this state of affairs continues it might start getting a bit more tricky,” said Kevin Thozet, a member of the investment committee of French asset manager Carmignac. 

The impact may be felt unevenly across the market. Major technology stocks, which have powered much of the S&P 500’s advance over the past year, may prove more resilient than some other companies to the impact on the price of US firms’ goods and services abroad from a strong dollar.

“Having a stronger currency makes US goods and services less competitive on an international basis,” said Jack Ablin, chief investment officer at Cresset Capital. “I’m not sure a strong currency is going to prevent someone from buying an Nvidia chip or using Amazon [but] we would probably see an impact in the midsection of the S&P 500.”

The rising dollar could also mean that, after lagging Wall Street’s gains over the past year, other regions’ equity markets could start to catch up.

“We may find ourselves in a period where markets away from the US could finally outperform,” said Andrew Cole, head of multi-asset at Pictet Asset Management.