I always make it a point to stress that there are four “risk-off” trades:
- Treasuries
- Gold
- Utilities
- The Dollar
Everyone seemingly has been screaming about a dollar bear market for the last several months following the peak in September of last year. I have been arguing quite the opposite lately.
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A robust U.S. dollar can pose challenges for American multinational corporations with substantial overseas revenues. Companies like Microsoft (NASDAQ:MSFT), Procter & Gamble (NYSE:PG) and Caterpillar (NYSE:CAT) have recently flagged that a strong dollar could erode their foreign profits. The strength of the dollar impacts businesses exposed to the European and Asian markets, recording significant currency impacts on their bottom line. If the dollar were to continue its ascent because of fears around a global credit event (which I keep stressing is a very real possibility), it will end up having nasty fundamental ramification on companies broadly.
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Why a Strong U.S. Dollar Poses Stock Market Risks
Emerging markets face the brunt of a strong U.S. dollar. These markets often rely on dollar-denominated debt for their growth. A rising dollar increases the cost of servicing these debts, potentially leading to financial instability in these countries. This could be particularly troublesome for China, which appears to be in a deflation cycle despite excitement around reopening its economy post lockdowns.
The stronger dollar also makes commodities, often a significant part of emerging economies’ exports, more expensive on the global market. This potentially affects their trade balance. Oil prices have been on the rise, and we know it’s not impossible to see oil rise and the dollar surge like we saw last year. We may be on the precipice of a sequel to that movie right now.
One way to capitalize on a rising dollar is to purchase an exchange-traded fund (ETF) like the Invesco DB US Dollar Index Bullish Fund (NYSEARCA:UUP). This ETF establishes positions in futures contracts to track the change of the U.S. dollar over time. It’s a convenient way to profit if the U.S. dollar continues to rise without directly trading currencies.
The Bottom Line
What’s the bottom line here? The rise of the dollar could signal an impending risk-off period, characterized by investor caution and a shift away from riskier assets.
During such periods, investors tend to flock to perceived “safe-haven” assets, often boosting the strength of the dollar further. This can result in a vicious cycle, causing significant strain on global markets. If a credit event were to occur — such as a sovereign default or a sudden stop in capital flows — the strain on global markets could be severe. Countries with high levels of dollar-denominated debt could find themselves unable to meet their financial obligations, leading to a potential crisis.
The soaring U.S. dollar, while presenting lucrative investment opportunities, also poses significant challenges. A strong dollar can cause ripples across the global economic landscape. It affects not just currencies and commodities, but also global trade, emerging markets and financial stability.
Proceed with caution. We shouldn’t want to make a profitable trade on the dollar because it could be a harbinger of bad things to come.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
