Stocks rise after two days of losses as financial stocks gain. The S&P adds 1.3% to 2,065 and the DJIA adds 1.5% to 17,895. Morgan Stanley, American Express, and Citigroup all gain as they announce dividend payments and share buybacks following successful Federal Reserve stress tests. U.S. retail sales fell unexpectedly in February which may support the case to delay interest rate hikes, which also contributed to today’s gains for equities. As a result, the U.S. dollar index fell .4% to 99.37 and the 10 year yield gains 1 point to 2.12%.
According to analysts at Morgan Stanley, the dollar is only halfway through its cycle and will continue to appreciate going forward. Head of global currency strategy says that demand from international investors seeking dollar-denominated assets is driving the appreciation, and those capital inflows will continue over the next year. In addition to Morgan Stanley, JP Morgan has also called for further gains against the euro and other emerging market currencies such as the Chinese renminbi and the Turkish lira. According to JP Morgan strategists, the dollar is behaving as if the Fed has already tightened by 100 basis points, which reflects that markets are expecting a multi-year divergence among the Fed and other central banks around the world. The dollar super-cycle typicalls lasts about seven years and consists of gains around 50% on average against a basket of other currencies. The dollar’s current rally has consisted of a 23% gain and dates back to 2012.
Next week the FOMC will have to consider the strength of the U.S. dollar when discussing interest rate increases. The appreciation in the dollar reflects the strength of the U.S. economy, however it may also be a hinderance to earnings and America’s trade balance going forward. Tightening policy in the U.S. coupled with easing policy in many foreign countries will continue to add to upward momentum on the dollar. According to a survey by Duke University, two thirds of companies that generate a significant portion of their sales overseas have been negatively affected by the dollar’s appreciation. The auto industry will be particularly hard hit, as companies such as Ford, GM, and Chrysler typically sell $140B of parts and vehicles overseas each year. However, recent jobs growth will be far more important in determining the interest rate outlook for the Fed.
U.S. banks experience the two sides of Fed stress tests. On one hand banks see the tests as useful and proactive to prevent future financial collapses, but on the other hand banks see the tests as expensive and excessive. A senior banking executive who chose to remain anonymous commented, “There’s a political mode of thinking that ‘more is better.’ That is not productive, or making us safer.” Banks are getting better at passing the quantitative part of the test which tests whether banks have enough capital to keep trading through a deep recession and a big shock to the financial system. The qualitative aspect tests ongoing and planned capital-management processes at the financial institutions. With banks doing well on these tests recently, they have been able to return more of their earnings to shareholders.