Dollar Rises as Government Shutdown Looms

Clouds may be gathering on the horizon for American markets as we near the fourth quarter of 2023. The threat of a government shutdown at the end of the month, as well as a strengthening greenback, could push key stateside Indices downward in the coming weeks.

USD’s Upward Climb

Market analysts are sounding the alarm on the recent surge of the U.S. dollar, cautioning that it could pose a significant challenge for U.S. Stocks, especially during an already challenging September.

Since early August, the U.S. dollar has strengthened beyond its average levels from the second quarter, shifting from being a boost to a hindrance for corporations as they close out the third quarter. A stronger dollar tends to negatively impact major U.S. multinational companies by making their products more expensive for international buyers and reducing the value of income earned overseas.

This increase in the U.S. dollar follows a notable climb in 2022, triggered by rising Treasury yields due to the Federal Reserve's aggressive interest rate hikes. Last year, the U.S. Dollar Index (DX) rose to a 20-year high of nearly $115 on September 27th, before dropping 9.5% by the end of the year. This decline was seen as beneficial for stocks, particularly the S&P 500 (US 500), which experienced a rally.

However, since mid-July, the DX has surged by over 6% as of the time of writing. Such a rapid rise in the dollar can have implications for company fundamentals and asset allocation.

In terms of market performance, small-cap stocks, whose revenues are primarily domestic, are typically expected to fare better during periods of a stronger dollar. On the other hand, cyclical stocks may face challenges.

Analysts at Morgan Stanley (MS) pointed out that a strengthening dollar tightens financial conditions, compounding the headwinds that U.S. Stocks are already facing as they approach the fourth quarter. They also highlighted other factors contributing to these headwinds, such as a 16-year high in the 10-year real rate and increasing Oil (CL) prices.

In summary, the recent surge in the U.S. dollar is viewed as a potential obstacle for U.S. multinational corporations and a factor adding to the challenges facing the stock market, particularly as it grapples with a difficult September.

Potential Shutdown Looms

Beyond day-to-day trading, a potential government shutdown could send ripples through global markets. As the U.S. government approaches a partial shutdown if funding legislation isn't passed before the morning of October 1st, it could lead to a delay in critical inflation data, essential for the Fed's policy decisions regarding rate increases. 

The Federal Open Market Committee (FOMC) recently held interest rates steady but signalled an expected quarter-point rate hike by year-end, and they are set to meet again on November 1-2. However, a potential U.S. government shutdown might impact the Federal Reserve's decision on another interest rate hike and could affect the recent strengthening of the U.S. dollar.

Although a government shutdown is not expected to be prolonged, it could briefly disrupt economic growth, influencing the U.S. dollar's trading. The dollar has exhibited strength in recent weeks, but a lack of necessary inflation data due to a shutdown might prompt the Fed to maintain current interest rates, potentially impacting the dollar negatively.

Consumer spending might also face pressure due to a government shutdown, particularly concerning issues like timely issuance of government benefits. The shutdown could result in furloughs without pay for federal workers and delays in government-backed loans.

In financial markets, a significant hindrance to consumer spending could prompt expectations of earlier interest rate cuts by the Fed, potentially lowering Treasury yields and potentially benefiting stocks. However, despite the possible negative implications of a government shutdown, it could provide support for the stock market as October approaches. (Source:Market Watch)

Conclusion

All in all, the coast for U.S. traders and investors alike is not clear as we head into the final quarter of the year. A confluence of factors could lead to recent economic trends, such as the rise of the greenback, being upended, and it is anyone’s guess what surprises may wait in store in the final three months of 2023.