The recent strength of the US dollar raises the possibility of a further shock to the economy beyond the recession, according to BofA Securities.
The dollar index (US DOLLARS) -0.3% is up more than 7% since the start of the year and crossed parity with the euro (FXE) +0.8% as the Fed remains aggressive in its tightening relative to other central banks.
Emerging Market Currencies (CEW) +0.5% have been under extreme selling pressure and this liquidation may still have more wiggle room, according to Wells Fargo.
“In many cases, despite global equities in bearish territory and the elevated risk of a global recession, currencies have yet to approach the upper limit of their segment’s potential depreciation range,” the economist wrote. Brenda McKenna in a note Friday.
A rising greenback often portends a credit event, as was the case in 1998, 2008 and 2020, BofA strategist Michael Hartnett wrote Friday in his weekly Flow Show note.
An “intense central bank hike cycle” is a risk to the current consensus of a shallow recession and “further significant rate hikes as central banks catch up in the coming months risk a” recession shock “transforms into a credit event (as strongly hinted at by the U.S. dollar),” Hartnett said.
Liquidation, deleveraging and default risks are high in areas such as private equity and venture capital (see Softbank’s credit default swap chart below), he added.
A third-quarter dollar spike in the absence of a credit event is the best path for a year-end rally in troubled cyclicals, but investors must choose which FOMC meeting (Sept. 20, Nov. 1) , Dec. 13) to flip their wallet forward, Hartnett said.
We “think November unless the market crashes in the next 8 weeks”.
For the broader market, BofA still says to nibble at S&P 500 (SP500) (SPY) 3,600, bite at 3,300 and binge at 3,000.
Find out why traders are back in camp on the 75bps hike today.