The Falling Dollar and Its Impact on the Stock Market

The recent drop in the value of the dollar is causing excitement in the stock market. After staying relatively stagnant for most of 2023, trading between $101 and $105, the greenback has finally taken a downward turn. As of Thursday, the U.S. Dollar Index (DXY) has experienced a 2.3% decline, reaching $99.89. This is the lowest level it has reached since April 2022, and it seems highly likely that it will continue to remain below $100. Interestingly, despite all the concerns surrounding interest rates and Treasury yields, the falling currency has yet to receive the attention it deserves.

According to John Roque, a technical analyst at 22V Research, there is a strong possibility that the U.S. dollar will become the dominant macro trade as bonds and interest rates continue to be in focus. This change in perspective suggests that the dollar is poised to make a significant impact on various markets.

Up until now, the dollar has been quite unremarkable this year. As noted by Alan Ruskin, a strategist at Deutsche Bank, the exchange rate between the euro and the dollar has remained within a narrow range of $1.05 to $1.10. This narrow range is reminiscent of the period following the collapse of Bretton Woods in the early 1970s when central banks across the Group of 10 countries were adopting similar monetary policies and there was little variation in economic strength.

However, things are about to change. A recent inflation report indicating that consumer prices rose by only 3% in June, falling short of projections for a 3.2% increase, has led to speculation that the U.S. Federal Reserve is nearing the end of its rate hikes, while other central banks continue to raise rates. This divergence in monetary policy could potentially shake up the currency markets. Deutsche Bank predicts that the U.S. may even slip into a recession while global economies continue to show resilience, which would further burden the dollar. If Ruskin’s predictions hold true, the euro could strengthen against the dollar, potentially reaching $1.15 or beyond.

The Weaker Dollar: Good News for Risk Assets

Thankfully, a weaker dollar should be good news for risk assets. While currency moves generally reflect differences in rates and growth, a strong dollar is typically a sign that investors are nervous. It’s no coincidence, then, that the stock market is rising at the same time the dollar is falling.

A Reflection of Risk Sentiment

According to Macro Risk Advisors technical analyst John Kolovos, the inverse relationship between stocks and the USD is a reflection of risk sentiment. He views the stock market’s rise and the falling dollar as indicators of investors’ flight to or away from safety.

Commodities Benefit from Risk

Commodities are among the beneficiaries of this flight to risk. Since oil and gold are priced in dollars, their prices rise when the dollar falls, all else being equal. And indeed, they are benefiting. On Wednesday, futures on WTI crude oil, the U.S. benchmark, gained 1.2% and closed at $75.75, the highest level in over two months. Gold futures also rose, increasing by 1.3% to $1,956.20, their highest close in nearly a month.

Potential Investment Opportunities

If the dollar continues to fall, the SPDR Gold Shares exchange-traded fund (ticker: GLD) or even the VanEck Gold Miners ETF (GDX) could be good bets.

Apart from commodities, investors should also consider materials stocks. Higher commodity prices can positively impact these stocks. The Materials Select Sector SPDR ETF (XLB) and the Industrial Select Sector SPDR ETF (XLI) usually trade together, but currently, XLB is below its record high while XLI is near a record high. According to 22V’s Roque, it’s expected that XLB will soon reach its former all-time highs, potentially resulting in a near-10% rally from the current levels.

In conclusion, when the bough breaks, the dollar will fall, and up goes the market, cyclicals, and all.