Dollar May Hold the Key to the Global Rally in Stocks

Stock markets started the year on a strong note, and everyone seems to be asking the same question: How much more can high-risk assets appreciate? The dollar may provide the answer.

The U.S. currency's weakness throughout 2017 provided much support for the domestic economy, arguably more than even the anticipation of tax cuts that boosted equities. It has also been great for the global economy, especially emerging markets, which have borrowed heavily in dollars in recent years. The dollar's depreciation also reflects a stronger euro and pound that resulted from strength in the European and U.K. economies.

There are costs associated with a falling dollar. In general, it means higher prices of commodities, which are settled in the U.S. currency. The rising cost of energy and materials has added to top-line inflation, bolstering the confidence of central bankers that their inflation targets will be reached soon. As such, traders have pushed short-term nominal interest rates higher. These, in turn, have begun to push real interest rates higher. A change in the landscape for real interest rates may help strengthen the dollar and, ultimately, damp the current Goldilocks-like feeling sweeping global markets.