The US dollar will continue to strengthen as investors grapple with recession fears – and is unlikely to peak until interest rates stabilize globally, according to JPMorgan.
The dollar has risen sharply this year and strengthened against rival currencies as the Federal Reserve raises rates to tame inflation. The U.S. dollar index, which measures the greenback against a basket of currencies, has risen 14% this year to $109.70, just below its 20-year high of $109.81.
But that spells trouble for stocks, as a strong dollar is a headwind for corporate earnings. Firms doing business overseas could see their foreign sales decline when U.S. goods become too expensive, according to JPMorgan strategist Gabriela Santos, who estimates that the dollar’s surge could shave $0.60 from the S&P 500’s operating earnings per share this year.
“This strength presents a mixed backdrop for the US economy by dampening inflation but dragging down real economic growth due to a widening trade deficit,” Santos said in a note on Thursday. “For US investors, the currency’s strength is compounding concerns about S&P 500 earnings growth and acting as a drag on international equity returns.”
But the dollar likely won’t top out until the gap between the Fed’s key rate and other central banks closes, she said.
According to Santos, the Fed’s aggressive rate hikes have widened the interest rate differential between U.S. Treasuries and foreign market bonds by 51 basis points over the past six months. The Fed leads other central banks in its key interest rate at 2.33%, while the European Central Bank raised its key rate to 1.25% earlier this month.
Concerns about a global recession also continue to push the dollar higher – meaning the economic outlook must also improve for the dollar to see some relief.
“Global growth concerns seem to have taken the front seat… In the short term, the dollar’s peak may be delayed as investors continue to grapple with fears of a global recession, keep asset volatility elevated and drag on international equity yields,” Santos said.
Those concerns aren’t likely to go away anytime soon, she warned. Europe is struggling to prepare for an energy crisis this winter that threatens to plunge its economy into recession, and China’s slow emergence from lockdown continues to fuel fears of a slump in global economic growth.
