U.S. dollar takes flight as markets lose ground

Greenback approaches 12-year high against euro as investors anticipate interest-rate increase

The American dollar soared — and stock markets sank — as investors came to grips on Tuesday with the likelihood of a U.S. interest-rate hike sometime this year by the Federal Reserve.

The greenback’s sharp rise — it’s now at a 12-year high against the euro — also comes as the European Central Bank (ECB) began a 19-month, trillion-dollar bond-buying program meant to stimulate the region’s moribund economy.

“The dollar’s rise against the euro is the expectation that the Fed will be raising rates this year and the ECB is doing the opposite,” James Marple, senior economist at TD Economics, told the Star.

The Canadian dollar, too, was caught in the rising greenback’s downdraft. The loonie lost 0.53 of a cent (U.S.) on Tuesday to close at 78.86 cents.

“We should see the Canadian dollar weakness continue for some time,” Marple said. “That is shielding us a bit from some of the headwinds of lower energy prices. It’s good if you have investments in U.S. dollars, but not if you’re planning to travel to the U.S.”

Stock markets across North America were in the red on Tuesday, nearly wiping out the gains made so far this year.

The Dow Jones industrials lost 332.78 points to close at 17,662.94 points Tuesday. The S&P 500 slipped 29.33 points to close at 2050.10. Both have slipped into negative territory for the year.

“You could see another round of dollar strengthening on the back of people again realizing that a Fed rate hike could be imminent,” Thierry Albert Wizman, currencies strategist at Macquarie Capital USA Inc. in New York, told Bloomberg. “U.S. rates are going up, the U.S. economy is good and the rest of the world is not in as good shape.”

In Toronto, the S&P/TSX Composite Index closed at 14,641.76 points, down 212.73 points from Monday’s close.

The triple-digit decline leaves Canada’s premier stock market index up just a sliver — 0.06 per cent — for the year to date.

The latest round of investor nervousness started Friday with the release of a better-than-expected U.S. jobs report. The Dow responded to the positive re- port — the jobless rate declining to its lowest level in almost seven years — with its biggest drop in five weeks.

“Equity markets are now getting religion on the fact that interest-rate hikes are coming,” Marple said.

Last week’s Labor Department report revealed the U.S. unemployment rate has fallen to 5.5 per cent.

The last time the jobless rate was that low, the benchmark U.S. federal funds rate was 2 per cent, Marple said. “We are (currently) at zero.”

The European labour market is in a very different condition.

“You don’t see the kind of consistent improvement you have in the U.S. going on in the European labour market,” Marple said. “They had fits and starts in the recovery, but nothing that has driven the unemployment rate down on a sustainable basis.”

On Monday, Dallas Federal Reserve Bank president Richard Fisher said policy-makers should move sooner and slower rather than later and faster. Markets could get more clarity on the Fed’s intentions when the central bank holds its interest-rate meeting next week.

For years, ultra-low interest rates have lured investors into stock markets in search of higher returns than they would get in bonds or GICs. Experts say the return to more normal levels of interest rates may spell an end to the six-year bull market for stocks.

Investors are also worried the higher U.S. dollar will cut into profit expectations, particularly for corporations that earn revenues abroad.

The U.S. Federal funds rate has been held at a record low of zero since December 2008. The last time the central bank raised interest rates was July 2006.

Options traders see a 56-per-cent chance the Fed will hike interest rates by September. The euro is likely to fall even farther against the U.S. dollar in the coming months, Marple said.

“I think even parity is probably likely as we get into the third quarter and those expectations are actualized with the Fed raising rates.” With files from Star wire services