Equities and crude down, US dollar up – When will the USD rally stop?

Mood in the European markets wasn’t so bad yesterday; most European indices eked out small gains despite a deepening energy crisis, and larger-than-expected fall in German factory orders.  

But the US session didn’t follow up on European gains, and the European futures point at a bearish start today. 

Equity selloff deepens as US companies rush to sell bonds before it gets more expensive

The three major US indices fell on Tuesday, the US yields spiked, and the dollar extended rally, as Americans returned from their Labor Day break.  

The S&P500 closed a couple of point above the closely watched 3900 mark, the major Fibonacci 61.8% retracement on the summer rally, which, if cleared should point at a deeper bearish trend in the medium run.  

On the other hand, the US companies are now rushing to sell bonds, before issuing debt gets more expensive with the prospects of a strongly hawkish Federal Reserve (Fed).  

Yesterday alone, 19 US companies including big names like Nestle, Walmart, Target and McDonalds issued a large amount of bonds – about $30 to $40 billion - following an almost 60bp point jump in high-grade yields since the beginning of August. That’s the largest amount sold since September last year.  

The US 2-year yield advanced above 3.50%, and the 10-year yield stretched above 3.35% for the first time since mind-June. 

The rising yields helped the US dollar extend rally, of course. The US dollar index is now above the 110 mark; the USDJPY spiked to 144, the EURUSD slipped below the 0.99 mark, the pound failed to hold the 1.15 support, and gold is now below the $1700 level, again.  

Bitcoin on the other hand accelerated the selloff, and is now below the $19K mark, as the bears are eyeing the June support of around $17500. 

When will the dollar rally stop? 

The stronger dollar is a growing headache, and we want to believe that the USD rally cannot continue forever, because a dollar this strong is also a growing headache for the US itself.  

We saw in the Q2 earnings that the dollar’s strength started weighing on US company profits. Also, the stronger dollar should have a negative impact on the US exports, making the US goods less affordable for the others, especially given that the world is struggling with a sharp decline in purchasing power.  

So, if the dollar continues rising at this speed, it’s not only that the countries other than US will continue seeing their energy bills, denominated in US dollars, inflate more than ‘necessary’, but the US economy will also hit a wall.  

Well, that’s a little bit what the Fed is trying to do. After having printed tens of billions of dollars to spur growth in the US, the US policymakers are having hard time cooling down the economy, and hitting the breaks. So maybe, hitting a wall is an option. 

But in all cases, if history is any guide, the US dollar could strengthen way more than now. If we go back to 80’s, when Volcker was hiking the interest rates at great speed to tame inflation, the US dollar also got very strong. The greenback gained about 50% against the Japanese yen, Deutsche Mark, French franc, and British pound from 1980 to 1985. And at some point, the dollar got so strong, that the dollar index spiked to 164 level, and the Japanese, the European and the American leaders had to meet at New York’s Plaza Hotel to reach an agreement to bring the greenback down!  

Now, of course, Jerome Powell is not expected to raise the rates as aggressively as Volcker, but if we think that 164 was the highest level reached by the dollar index back in 80s, we still have, in theory, a long way to go. 

Other central banks also raise rates, but

The Bank of Canada (BoC) is expected to hike by 75bp for the 4th consecutive meeting today, and the European Central Bank (ECB) is expected to raise its rates by 75bp tomorrow.  

The euro clearly looks bad, and the Loonie doesn’t look any better, and we are not convinced that a rate hike could give the Loonie the positive spin it needs. The weakening oil prices will likely continue weighing on the Canadian dollar. 

And speaking of oil

Crude oil extends losses. The barrel of American crude is about to test the $85 support at the time of writing. The downside pressure is explained by the growing fear of recession. Clearing the $85 support should pave the way toward the $80 mark, which is the post-pandemic uptrending channel base.  

Below that level, OPEC will certainly show up and say, they are cutting output to further stabilize the market.