Unrestrained Appreciation of Dollar Index Threatens to Disrupt Performance of Upcoming Quarterly Stock Earnings

The U.S. dollar index (DXY) has been steadily growing lately, driven by increasing risk-off mode associated with many recent and ongoing turbulent events across the globe causing U.S. bond yields to rise. Over the past month, DXY appreciated from the still-overheated 92.5 to today’s eye-popping 94.25, the highest level since September 2020. The indicator that measures the dollar against a basket of currencies has been growing almost uninteruptedly since June.

A strong dollar acts as a brake on further stock price increases in the wake of the upcoming Q3 2021 corporate earnings reports. According to FactSet, nowadays, S&P 500 companies generate 40% of their revenues outside the U.S. When the dollar appreciates this quickly, the value of overseas earnings plummets. “A stronger dollar can be a kind of wrecking ball. Overall, this is a tightening of global financial conditions, ” – said James Eti, investment manager at Aberdeen Standard Investments.

The dollar's rise was fueled by expectations that the Federal Reserve will act earlier and more aggressively to remove pandemic-era stimuli. Supply chain disruptions, skyrocketing energy prices and operational disruptions in markets including China and the UK have also impacted global growth prospects.

The global reserve currency tends to rise under two scenarios: when the global economy is doing badly and, accordingly, investors are fleeing into safe-havens, and, conversely, when the U.S. economy is doing well compared to other world economies, which prompts investors to buy dollar-denominated assets. This is called the dollar smile because in these two cases the curve rises and flattens in the middle. Right now, there are elements of both ends of the smile nudging investors towards the dollar.

Meanwhile, the world's major central banks are signaling their intention to cut stimuli, which will lead to higher bond yields. Federal Reserve Chairman Jerome Powell said in late September that the central bank will likely announce the tapering start at its next meeting in November. Fed officials are also increasingly signaling that interest rates may rise as early as next year – something which is particularly hard to believe.

Nearly all US government bonds have sold out as investors prepare to price-in the Fed's massive presence in the markets. The yield on 10-year Treasuries rose above 1.5% this Monday alone for the first time since June and remained above the threshold for most of the week. Profitability rises when prices fall. Its growth attracts investors seeking to fix higher returns, which increases the demand for the dollar. Let’s see how Feds are going to manage this situation as time for the first company’s quarterly reporting is running out.