Market gains fueled by a lower dollar

Investors can thank the European Central Bank (ECB) for most of the market’s gains this week. The IECB raised their benchmark interest rate by 50 basis points on July 21, 2022. It was the first interest hike in more than a decade, which strengthened the euro, while weakening the dollar. That boosted U.S. equities.

“Inflation continues to be undesirably high and is expected to remain above our target for some time,” explained ECB President Christine Lagarde. At the same time, she warned Europeans that they should expect a slowdown in growth for the second half of 2022 and beyond.

At the same time, Lagarde announced a new tool, the Transmission Protection Instrument (TPI), aimed at shoring up those nations already reeling from high debt levels and even higher borrowing costs such as Italy. Italy is already undergoing political turmoil as a result of the resignation of its highly regarded Prime Minster, Mario Draghi. The country, which is highly dependent on energy imports from Russia, is grappling with higher inflation and falling growth.   

The TPI will be employed if a nation’s borrowing costs begin to surge for reasons outside of their control (meaning market turbulence, rather than a country’s particular set of economic and fiscal policies). The ECB would then be prepared to purchase their public-sector debt, and even private-sector assets, if appropriate.

Readers may recall that last week the U.S. dollar reached parity with the euro. Short-term, that was the high point of the dollar’s strength. Since then, currency traders have been selling down the dollar and buying the euro in anticipation of the ECB’s interest rate decision. This week, the exchange rate has moved up to 103 euros to the dollar. As such, the weaker dollar provided fuel to U.S. equities. Investors, you may recall, are worried that the strength of the dollar is damaging the financial prospects for U.S. multinational corporations here at home.

IBM, for example, in announcing their second-quarter earnings, took a hit of $900 million in revenues due to currency translations. Microsoft, which generates about half their profits from outside the U.S., has already warned the Street to expect lower sales and profits due to the strength of the dollar.

Investors have been playing a game of “who’s next” dollar-wise, as earnings season gets underway. A growing group of company managements have pointed to the dollar as a reason for caution in the months ahead. Other quarterly results seem to indicate a slowing of the economy, weaker consumer demand and, in the case of social media company, Snap, weaker advertising revenues.  Netflix and Tesla, big weightings in many equity indexes, announced earnings that were not as bad as expected. Overall, earnings have been mediocre at best, in my opinion.

The markets have trended up nicely this week and the gains may not be over. Technical would say that after a pullback in the S&P 500 Index at around the 4,030 area, we could see the index climb to the 4,100-4,200 area. What would be the catalyst for such a move?

The Fed meets again next week, and some bulls are betting that we have seen peak inflation. At the same time, the economy is slowing. That combination may convince the Fed to go a little slower and become a little less hawkish. Let’s hope that happens.

Bill Schmick is registered as an investment advisor representative of Onota Partners, Inc., in the Berkshires.  Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners, Inc. (OPI).  None of his commentary is or should be considered investment advice.  Direct your inquiries to Bill at 1-413-347-2401 or e-mail him at bill@schmicksretiredinvestor.com .Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.