The October retreat in U.S. stocks has led to a repricing of the U.S. dollar, giving market participants yet another indication that the days of the dollar rally could be numbered.
U.S. equities have been soggy at best after the Dow Jones Industrial Average sold off nearly 1,400 points over the span of two days last week. In the month to date, the Dow
and S&P 500
are down 4.6% and 5.6%, respectively, according to FactSet.
“The pullback in U.S. stocks reflect a host of different factors but the range break of real yields introduces fresh uncertainty around the world’s financial plumbing,” said Mark McCormick, North American head for foreign-exchange strategy at TD Securities. “In turn, a higher VIX challenges the risk-adjusted performance of U.S. assets, leaving the dollar vulnerable to a shift in flows, sentiment and positioning.”
The CBOE Volatility Index, or VIX
, is a measure of market volatility that has turned higher this month.
“Over the coming days and weeks it will become obvious whether the latest sharp move in the U.S. stocks and the dollar are a correction within a bull trend or whether they are instead a turning point in market sentiment,” wrote Jane Foley, senior currency strategist at Rabobank.
All this will likely increase the scrutiny around third-quarter earnings releases, which are beginning to trickle in, especially concerning guidance on the impact of foreign-exchange swings, wages and other price pressures, according to McCormick. In response, the buck, measured by the ICE U.S. Dollar Index
, would likely trend toward the lower end of its summertime range, between 94-96. That view is based on a change in market sentiment toward U.S. assets, stretched positioning in the dollar and some loss in its relative growth momentum.
The gauge so far is down 0.1% in October, according to FactSet.
Indeed, the strong economic momentum in the U.S. that boosted the greenback as well as stocks for much of this year has ebbed, McCormick said. Across the board, market participants are beginning to look for upside economic data surprises in Europe more so than the U.S., hoping that the European underperformance of 2018 would be followed by a bounce back.
“Besides a few hits here and there, U.S. data has been mostly lackluster since Q1. The current level and 3-month rate of change of the U.S. surprise index sits near the bottom end of the G10 league table,” said McCormick.
“That means, the dollar is not the only growth currency in town and argues that much of the goods news might be priced in. That puts a lot of emphasis on sentiment and positioning, especially ahead of the midterms that might generate some caution on the #MAGA theme,” he said, referencing President Donald Trump’s “Make America Great Again” slogan.
Further, as the Federal Reserve is quite far along in its dollar-supportive interest-rate normalization cycle — having hiked rates for an eighth time since late-2015 last month, the focus is now shifting to the European Central Bank. The ECB is expected to jump on the rate-hike band wagon around the summer of next year.
No rate changes are expected at this week’s Fed meeting, but another rate hike is expected in December. This means the buck may not have peaked yet, still, “we are of the view that by the second half of next year the market will be looking at a less attractive backdrop for the dollar,” Foley said. “By then, slowing U.S. growth, plateauing Fed interest rates and potentially a greater focus on the budget deficit could be clouding the outlook for the dollar.”
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