In Q3, the US dollar index rose to a two-decade high. The dollar index, which has a 57.6% to the euro currency, rose 7.29% and was 17.25% higher than December 31, 2021, close. An over 17% rally in a currency is a significant event as currency volatility tends to be low as governments manage the foreign exchange markets to provide stability for cross-border payments and the global economy.
Meanwhile, interest rates have exploded higher in 2022. At the end of 2021, the short-term Fed Funds Rate stood at 0% to 0.25%, and the benchmark is now at 3.00% to 3.25%. Moreover, the US 30-Year Treasury bond futures fell 8.61% in Q3 and were 21.17% lower over the first nine months of 2021, falling to the lowest level since 2011.
The rising dollar and trend in interest rates have been a potent bearish cocktail for the stock market. The days of cheap or free financing are over, and an increasing dollar weighs on earnings for US multinational companies.
Moreover, the geopolitical landscape has increased uncertainty, exacerbating selling in equities. The results in Q3 and over the first nine months of 2022 have been nothing short of ugly. However, the overwhelmingly bearish sentiment could be the most bullish factor for stocks.
The leading stock market indices are trending lower
- The DJIA fell 6.66% in Q3 and was 20.95% lower over the first three quarters of this year.
- The S&P 500 dropped 5.28% in Q3 and 24.77% since the end of 2021.
- The tech-heavy NASDAQ was 4.11% lower in Q3 and moved 32.40% to the downside over the first nine months of 2022.
- The stock market behaved like a game of whack-a-mole.
The dollar index is getting toppy
- The dollar index rose to a 114.745 high on September 28, the highest level since 2002.
- Bull markets rarely move in straight lines; corrections can be fast and furious.
- The index corrected to just below the 112.700 level on October 7 but remains in a bullish trend.
Bonds have declined to a decade low
- Nearby US 30-Year Treasury bond futures fell to 123-30 on September 28, the lowest level since 2011.
- While the long bond has been in a bearish trend since 2020, recovery rallies have routinely followed new multi-year lows.
- The December long bond futures were above the 125 level on Friday, October 7, and remain in a bearish trend.
The Fed faces a challenge that could curb its enthusiasm for rate hikes and QT
- GDP declines in Q1 and Q2, and economic conditions will likely cause a third consecutive contraction in Q3.
- Economic textbooks define a recession as two consecutive quarterly GDP declines; a third would be another validation.
- Recession and inflation require mutually exclusive monetary policy tools. Increasing interest rates combat inflation, while decreasing rates is the treatment for an economic downturn.
- A continuation of GDP declines will make the Fed economists think twice about the current hawkish path.
An overabundance of bears could be the most bullish factor for stocks in Q4
- Over 20% declines in the DJIA and S&P 500 and a more than 30% drop in the NASDAQ have caused bearish sentiment to increase.
- The mid-term elections are on the immediate horizon- Voters tend to choose candidates based on their pocketbooks.
- Too many bears often lead to vicious and sustainable rallies as markets run out of selling and vacuum to the upside.
- Corrections in the dollar and the bond market set the stage for rip-your-face-off rallies in the current environment.
- A sudden end to the war in Ukraine could cause an explosive rally in the stock market.
- The stock and bond markets remain in bearish trends, but that does not mean they cannot suddenly surprise on the upside.
Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!