Recession fears could support dollar after sharp gains in 2022

NEW YORK: The dollar’s stunning surge has trampled foreign currencies, hurt corporate profits and delivered one of the few profitable trades for investors this year. economic recession Concerns are likely to continue to grow in 2023.

When the dollar peaked in September pace Higher interest rates boost the dollar.

While rising U.S. yields were a key catalyst for the dollar’s gains, other factors also played a role. Investors have flocked to the dollar – a popular investment destination in times of uncertainty – to escape market turmoil caused by surging global inflation, surging energy prices and Russia’s invasion of Ukraine.

The relative strength of the U.S. economy has also boosted the dollar’s appeal at a time when energy crisis concerns have hit European assets hard and strict COVID-19 controls have hurt China’s economic growth.

Even if it gives back some of its gains, the dollar is still on track for its best annual performance since 2014. The dollar was the market’s most crowded trade for a fifth straight month in November, according to fund managers surveyed by BoFA Global Research, with a record number of survey participants saying the greenback was overvalued.

However, a Reuters poll of 66 foreign exchange strategists showed the dollar will remain at current levels in about a year, with many expecting global central bank tightening to hurt economic growth and boost the dollar’s safe-haven appeal again.

Why it matters

It is crucial for investors to correctly judge the direction of the US dollar because the direction of the US dollar affects everything from corporate earnings to the prices of raw materials such as oil and gold.

A stronger dollar makes U.S. exporters’ products less competitive abroad and hurts U.S. multinationals that need to convert earnings into dollars. The S&P 500 has about 30% of foreign exposure, with the technology and materials sectors most vulnerable, according to Bank of America.

Nike, IBM and Meta Platforms are among a host of companies that have warned of a hit from a stronger dollar this year. Tom Lee, head of research at Fundstrat Global Advisors, said the dollar’s rise has reduced S&P earnings by about 8% in 2022.

For the rest of the world, a stronger dollar will weigh on the prices of oil and other dollar-denominated commodities by making them more expensive for foreign buyers, while also making it more expensive for foreign companies and governments that borrow dollars to repay debts.

While a stronger dollar can curb U.S. consumer prices, it can also push down other countries’ currencies, fueling global inflation. The International Monetary Fund estimated in October that, on average, a 10% appreciation in the dollar would pass on inflation to 1%.

What does this mean for 2023?

There are signs that sentiment on Wall Street toward the dollar may be shifting. Data showed consumer prices fell less than expected in October, sending the dollar down 5% against a basket of currencies last month, its biggest monthly drop since 2010.

In the futures market, speculative traders switched to a net short position on the dollar for the first time in 16 months in November, according to Reuters calculations based on data from the U.S. Commodity Futures Trading Commission.

Whether the dollar continues to fall may depend on whether the Federal Reserve can effectively control inflation and eventually ease monetary policy. If mild inflation data appears in US data due next week, it may provide a basis for further decline in the dollar.

Investors are also waiting for the conclusion of the Federal Reserve’s monetary policy meeting on December 14. The market generally expects the Fed to slow down the pace of interest rate hikes and raise interest rates by 50 basis points at this meeting.

In the long term, economic concerns could be a driver of the dollar’s performance. Nearly 80% of strategists polled by Reuters said the dollar had little room to rise based on monetary policy.