Stock recovery depends on dollar
NEW YORK: It’s hard to imagine investor sentiment being any worse than it was coming into last week. The Dow Jones Industrial Average was down 35% from its high for the year in February, and more than a few Wall Street strategists were calling for a drop of 50% or more before it was over.
What a difference a few days make. The benchmark briefly entered a (technical) bull market last Thursday, rising 20% over the course of three days from its lows on Monday. False rallies are a hallmark of bear markets, and this could be one of those, but the latest turnaround had one big thing going for it.
Rather than sudden confidence in the battle against the pandemic and a subsequent quick rebound in the economy and corporate profits, much of the recovery can be tied to the dollar.
As equities soared over three days before profit-taking set in on Friday, the Bloomberg Dollar Spot Index, which measures the greenback against a basket of major currencies, tumbled 3.8% after surging 8.9% in the previous two weeks.
Given its haven status, it’s not unusual for the dollar to strengthen in times of crisis. The problem is, the global financial system is tied to the dollar like never before, and its appreciation causes financial conditions around the world to tighten.
The most visible example is in the debt markets, with the Institute of International Finance estimating that emerging-market borrowers alone have $8.3 trillion in foreign-currency debt, the bulk of it in dollars, up more than $4 trillion from a decade ago.
Any rise in the dollar makes it that much more expensive for these borrowers to make interest payments or refinance, which would only exacerbate the deep recession facing the economy.
Much of the dollar’s recent weakness can be tied to one key move by the Federal Reserve to ease the run on the US currency. What the Fed did was provide foreign-exchange swap lines with central banks in both developed and emerging markets, offering dollars in exchange for their currencies.
The dollar “may now become a barometer of the efficacy of the policy response to corporate credit difficulties, interbank funding challenges, etc”, Standard Chartered currency strategists Eric Robertson and Steve Englander wrote in a research note.
“Global policymakers have adopted a ‘whatever it takes’ approach to countering financial-market volatility and the expected recession, but this response may also need to have an impact on the (dollar) to be seen as truly effective.”