U.S. dollar has become ‘a bit of a wrecking ball,’ strategist says

DailyFX.com Senior Strategist Christopher Vecchio joins Yahoo Finance anchors Brad Smith, Julie Hyman and Brian Sozzi to discuss the British pound, the UK’s inflationary and labor market issues, and the strengthening of the U.S. dollar.

Video Transcript

BRAD SMITH: Feeling the pinch of inflation here in the US, and we're not alone. The UK hit a 40-year inflation high due largely, in part, by the growing cost of food. The month of September saw a 10.1% year over year increase in the UK. And the British pound taking a hit on the news, dropping slightly this morning. For more on this, let's bring in Dailyfx.com senior strategist, Christopher Vecchio. Chris, great to speak with you and get some of your insights around this. Is this expected to kind of dwindle down at any point in the near future?

CHRISTOPHER VECCHIO: Well, for the UK, they're facing a very difficult economic situation. It's much more of a stagflation situation than we're seeing here in the United States. Their labor markets are already starting to slow down. Growth on a month over month basis has been negative recently. And of course, we're now seeing double digit inflation. This is leaving the Bank of England in quite the policy bind, right? If they raise interest rates to cut off inflation, they choke off growth. And if they don't raise rates fast enough, well, sure, growth may be better, but inflation can continue to rear its ugly head.

But the BOE is facing the same problem that so many of the other world's major developed central banks are facing, which are supply chain issues and supply side issues that have pushed up inflation to where it is today in the wake of the pandemic. So for the UK, we still probably have enough-- another rough few months ahead of us here. Same thing for the eurozone, as we move into this winter period where, of course, energy demand will be higher and there are concerns about supply here moving into the fourth quarter.

JULIE HYMAN: Yeah, definitely the UK has been sort of emblematic of the volatility in this market, some of it brought on by policymakers, whether it's at the government level or at the central bank level. Here in the US, we're seeing a sort of interesting phenomenon unfold over the earnings season thus far, Chris. And that is, things seem OK, surprisingly.

But the big fly in the ointment does seem to be currency for a lot of companies that we've been talking about. How much of a problem is that? And do you think that is going to continue to be? I mean, you watch FX very closely. Are we just going to continue to see the dollar strengthen?

CHRISTOPHER VECCHIO: It's certainly a problem in the near-term. We don't have all the data available for the third quarter just yet, but a significant number of companies have reported that FX has had a negative impact on their bottom line. In the second quarter, when the dollar index rallied at 6.5%, the hit to North American and European multinationals was roughly $49 billion, the largest such ever hit to their earnings as a result of FX volatility.

And so when you think that the dollar has just risen 7% here in the third quarter, yes, maybe some of these companies hedged a little bit more. But if it's been Johnson & Johnson or if it's been in the airlines, even if it's been something like Procter & Gamble-- Netflix, we've heard that the strong dollar has led to a reduction in earnings coming from abroad. So this is likely to continue here. I do think it's going to be another rough third quarter in that regard, as we've already seen.

But the dollar index can continue to rally here. This key fact is that the Federal Reserve right now is maintaining such a significant yield advantage, both in nominal and real terms, against the other major central banks that the dollar has become a bit of a wrecking ball. Even these intervention efforts by the Bank of Japan and the Ministry of Finance are proving ill-fated because, quite frankly, as long as that policy gap remains, there's really no stopping the US dollar versus a low yielding currency like the yen.

And so any time there's been an intervention or a rumor of an intervention, it's been faded not days later, but almost hours later at this point in time. So right now, the dollar remains poised to continue that strength. We've recently seen Fed funds expectations move up the price in a 4.95% terminal rate next year. That's a significant increase from where we were prior to the September Fed meeting. And that only means the dollar has a bigger cushion underneath it than it did just a few weeks ago.

BRIAN SOZZI: Chris, in a mild recession, how much does the dollar fall?

CHRISTOPHER VECCHIO: That's the problem right now. I don't think the dollar falls back all that much, to use an old axiom that I feel like was around during the 2010s when we were talking about the eurozone debt crisis and the dollar strength. But the dollar remains the nicest house in a bad neighborhood. And as long as the other countries are dealing with recession or stagflation, they have the broken windows and the weeds on their property. It's difficult to suggest that people aren't going to flock to the greenback right now.

So from my perspective, the dollar may trade sideways as a result of a recession. But if the US is in a recession, it means that you're dealing with a lot worse of a situation. The Canadian economy is slowing down. And now with zero-COVID continuing in China, even the Australian and New Zealand dollars don't look like they'll be able to get off the mat anytime soon. So dollar strength, king dollar continues to reign.

BRIAN SOZZI: Dailyfx.com senior strategist Christopher Vecchio, always good to see you. We'll talk to you soon.