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Why an epic US dollar rally could be a ‘wrecking ball’ for financial markets

Why an epic US dollar rally could be a 'wrecking ball' for financial markets

The U.S. dollar is on a tear, hitting all-time highs against its major rivals and sending ripples through global financial markets as investors watch the Federal Reserve hike interest rates in its bid to tame inflation .

“It’s no surprise the dollar hit a new all-time high on both safe-haven inflows from global economic weakness and a resilient U.S. economy paving the way for the Fed to stay aggressive,” said Edward Moya, senior market analyst at Oanda. “The king of the dollar has woken up from a nap and it could be a lot more painful for European currencies.”

  • The dollar rose 0.8% against the Japanese currency USDJPY to 140.03 yen, trading above 140 for the first time since August 1998, according to FactSet.

  • The euro EURUSD fell back below parity, losing 1.1% to reach 99.46 US cents.

  • The British pound GBPUSD,
    -0.70%
    fell 0.7% to trade at $1.1542, its lowest level since March 2020.

  • The dollar rose 0.2% against the Chinese yuan USDCNY, trading near an over 2-year high.

  • Meanwhile, the ICE US Dollar Index DXY, a measure of the currency against a basket of six major rivals that weighs heavily on the euro, rose 0.9% to 109.69 after falling traded just below 110 – its strongest since 2002.

A lockdown of Chengdu, a city of 21 million people by Chinese authorities, has raised concerns about global growth and interest in the dollar, analysts said. The dollar was further strengthened on Thursday morning after data showed early jobless claims fell last week to a nine-week low of 232,000, showing no signs that a slowing US economy is triggering headwinds. widespread layoffs.

The rally accelerated after the Institute for Supply Management said its manufacturing index held steady at 52.8% in August as new orders and employment turned positive again and inflation eased – a reading above 50% signals expansion. Economists polled by The Wall Street Journal had expected the index to fall to 51.8%.

“It really is a Goldilocks report if you are a US Dollar bull. Not so much for anything else, which continued to be absolutely flushed,” Michael Hewson, chief market analyst at CMC Markets, said in a note.

U.S. stocks were down in afternoon trade but off the day’s worst levels, on track for a fifth straight losing session after Fed Chairman Powell’s August 26 speech warning that economic trouble could be on the horizon as the central bank battles inflation.

The Dow Jones Industrial Average DJIA,
+0.06%
was down 73 points, or 0.2%, while the S&P 500 SPX,
-0.27%
lost 0.8% and the Nasdaq Composite COMP,
-1.03%
fell 1.7%. Treasury yields jumped, with the 2-year rate TMUBMUSD02Y,
3.532%
exceeding the 3.52% level and the 10-year yield TMUBMUSD10Y,
3.268%
up more than 13 basis points to trade near 3.265%. Yields and debt prices move in opposite directions.

“The Fed’s aggressive rate hikes have led to moves in major currency pairs as Germany-US and Japan-US rate spreads widen. The EUR and JPY are the two most important components of the Dollar Index (DXY), and the prospect of more aggressive Fed tightening would only exacerbate these macro trends,” analysts said. PGM Global, a Montreal-based research firm, in an August article. 26 grades. “Meanwhile, the Fed pivot is priced out of 2023, reinforcing our view that a stronger broad USD is still on the path of least resistance,” they wrote.

The surging dollar weighed on commodities, with the US crude benchmark CL.1,
-3.37%
falling 3.5% to trade above $86 a barrel, while gold GC00,
-1.15%
fell 1% to trade near $1,709 an ounce.

PGM Global analysts said the rising dollar could sow the seeds of greater currency volatility as foreign central banks deplete foreign exchange reserves, particularly dollar holdings, in a bid to stabilize their own currencies.

“There has been a desire among central banks and sovereign wealth funds to diversify foreign exchange reserves into gold and other stable currencies. However, this slow dedollarization trend has not led to a weaker dollar,” the analysts said.

“Indeed, quite the contrary, as the macro factors align far too strongly in favor of the USD. Thus, prematurely selling USD reserves could be a costly policy mistake and exacerbate currency and equity volatility,” they wrote.

The 16 largest holders sold a total of $672 billion in reserves year-on-year through July, PGM Global said, citing data from the International Monetary Fund. “As the Fed mops up USD liquidity, the US dollar ‘wrecking ball’ appears to continue to accelerate,” they wrote.

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