The brutal U.S. stock-market selloff that dominated the first six weeks of the year has been erased—and investors might have the dollar to thank for that.
Slowing global growth, worries about a sharp devaluation in the Chinese yuan, stubbornly low oil prices, and the Federal Reserve’s decision to raise interest rates in December are all factors that investors have blamed for the turmoil in global markets this year.
But the market’s reaction to the outcome of Wednesday’s Federal Reserve meeting perhaps revealed the true culprit: the strong dollar.
“A lot of the market convulsions looked like they were coming from independent things. But they all had a common denominator and that’s the dollar,” said Binky Chadha, chief global strategist at Deutsche Bank, in a phone interview.
The Fed on Wednesday surprised investors by striking a more cautious tone—projecting just two rate increases in 2016 compared with its December forecast for four increases. The dollar fell sharply versus major rivals, with the ICE U.S. dollar index , a measure of the currency against six major rivals, falling to its lowest level of 2016 on Thursday.
The less aggressive tone has many currency strategists—including Vasileios Gkionakis, the global head of currency strategy at UniCredit—optimistic that the dollar will continue to weaken this year.
This bodes well for U.S. equities. Indeed, the Dow industrials and S&P 500 both turned positive for the year on Thursday. And investors are optimistic that the recent bout of volatility is over—at least, for now.
There are several ways by which the dollar exchange rate feeds through to other markets.
When the dollar is weak, crude oil—which is priced in dollars—becomes more affordable to buyers who use other currencies. This can boost demand, driving prices higher. Indeed, the dollar and prices for oil and other commodities have historically maintained an inverse relationship. Oil futures rallied sharply Thursday, pushing the U.S. benchmark above $40 a barrel for the first time in 2016.
Stronger prices for oil and metals could offer some relief for beaten-down energy and mining firms.
Also, a weak dollar makes its easier for U.S. companies to turn a profit.
Since the second quarter of 2015, companies based in the U.S. have regularly blamed the strong dollar for weaker than expected earnings. This could well change when companies report second quarter earnings, with the ICE dollar index down nearly 5% from its level a year ago.
“A higher dollar had a negative impact on overseas earnings of U.S. companies over the past several quarters. As the dollar stabilizes and the economy continues to improve, we will start seeing better earnings,” said Colin Cieszynski, chief market strategist at CMC Markets.
To be sure, potential headwinds remain. After the second Fed rate increase, which many investors expect will happen in June, the dollar could resume its march higher.
But for now at least, the Fed has given investors one less reason to complain.
Written by Joseph Adinolfi of MarketWatch