This is the conclusion of today’s Morning Brief, which you can read Log in Delivered to your inbox every morning, along with:
The U.S. dollar index (DX-Y.NYB) rose to its highest level since November on Tuesday, while the 10-year U.S. Treasury yield (^TNX) also hit its highest level since 2007.
Stocks plunged, sending the Nasdaq Composite (^IXIC) down 1.6%, or about 9%, from its July high. The S&P 500 (^GSPC) followed suit, ending the day down 1.5%.
Meanwhile, the CBOE Volatility Index (^VIX), known as the “fear gauge,” settled at its highest level since May and the Ice BofA MOVE Index (^MOVE) jumped, all signs of risk aversion.
It was all thanks to the Fed. While the dollar and Treasury yields have been trending upward for months, last week’s release and press conference accelerated the rise in interest rates to new multi-year highs. Investors were once again caught on the wrong foot and were forced to price in even higher interest rates for a longer period of time.
Higher government yields and lower bond prices are attracting new investors to the U.S. from abroad, who must first buy dollars to buy these bonds – creating a virtuous cycle of higher interest rates and a stronger dollar.
Unfortunately, the speed of movement in the heavily leveraged world of bonds and currencies is disrupting the significant sluggishness of global markets – all of which weighs on risk markets like stocks.
The US Dollar Index looks set to complete its 11th week of consecutive gains. And barring an unusual and significant decline, the dollar will be technically overbought in the Relative Strength Index this week – the first such signal in nearly a year.
Meanwhile, the 10-year yield is also close to seeing its own overbought signal on the weekly time frame – also a first in almost a year. In fact, the rally in U.S. stocks that began last October came as both the dollar and the 10-year note worked off their overbought status with a temporary sideways move lower.
The story goes on
Overbought dollars and yields – and especially increases in both – are associated with difficult times for stocks.
The chart above shows that the last time yields and the dollar were overbought coincided with the bear market in 2022, and these challenges are surfacing again as the single purple dot points out. Often, but not always, market turmoil has coincided with these overbought signals – the global financial crisis and the COVID crash being two major exceptions. (This turbulence had other reasons, of course.)
If these current moves are implemented, stocks may have already paid a sufficient price to continue their advance after this “healthy” decline. But history shows we are at least a few weeks away from that point.
All of this should give equity bulls hope that stocks can regain their footing once the current turmoil in bond and currency repricing is over. At some point interest rates and the dollar will settle into a new equilibrium and risk markets may return to being a little riskier (i.e. higher stock prices).
Until then, stocks could face another difficult phase.
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