We’re Now In a Bull Market? Thank the Dollar

It’s hard to imagine sentiment being any worse than it was coming into this week. The Dow Jones Industrial Average was down 35% from its high for the year in February, and more than a few Wall Street strategists were calling for a drop of 50% or more before it was over. What a difference a few days make. The benchmark briefly entered a (technical) bull market on Thursday, rising 20% over the course of three days from its lows on Monday. False rallies are a hallmark of bear markets, and this could be one of those, but this turnaround has one big thing going for it.

Rather the some sudden confidence in the battle against the coronavirus pandemic and a subsequent quick rebound in the economy and corporate profits, much of the recovery in stocks can be tied to the dollar. As equities have soared the past three days, the Bloomberg Dollar Spot Index, which measures the greenback against a basket of major currencies, has tumbled some 3.78% from a record high after surging 8.91% the previous two weeks. Considered a haven, it’s not unusual for the dollar to strengthen in times of crisis. The problem is, the global financial system is tied to the dollar like never before, and its appreciation causes financial conditions around the world to tighten. The most visible example is in the debt markets, with the Institute of International Finance estimating that emerging-market borrowers alone have $8.3 trillion of foreign-currency debt, the bulk of it in dollars, up more than $4 trillion from a decade ago. So, any rise in the dollar makes it that much more expensive for these borrowers to make interest payments or refinance, which would only exacerbate the deep recession already facing the global economy.