Why do rising dollar and Treasury yields affect stocks?

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The US Dollar Index (DX-Y.NYB) rose to its highest level since November on Tuesday, as the 10-year US Treasury yield (^TNX) also reached its highest level since 2007.

Stocks fell, sending the Nasdaq Composite Index (^IXIC) down 1.6%, or about 9% from its July high. The S&P 500 (^GSPC) followed suit, ending the day down 1.5%.

Meanwhile, the CBOE Volatility Index (^VIX), known as the “fear gauge,” held at the highest level since May and the Ice BofA MOVE (^MOVE) index jumped — all pointing to risk aversion.

And it was all because of the Fed. While upward trends in dollar and government bond yields have been underway for months, last week’s release and press conference accelerated the rise in interest rates to new multi-year highs. Investors have once again been caught out and forced to price out It’s even higher rates for Even longer.

Sovereign yields rise and bond prices fall Attracting new investors to the United States from abroad, who must first buy dollars to buy said bonds — a virtuous cycle of higher interest rates and a stronger dollar.

Unfortunately, the speed of movements in the highly leveraged world of bonds and currencies is disrupting the great stagnation in global markets – all of which affects risk markets such as stocks.

The US Dollar Index is set to close its 11th week of consecutive gains. Barring an unusual and large decline, the dollar will technically fall Overbought On the RSI This week – the first such signal in nearly a year.

Meanwhile, the 10-year bond yield is about to record its overbought signal on the weekly time frame – also the first in almost a year. In fact, the rally in US stocks that began last October came as both the dollar and 10-year bonds managed to shake off their overbought condition by moving sideways to the downside for a period of time.

Overbought dollars and yields – especially rises in both – are associated with tough times for stocks.

The chart above shows that the last time yields and the dollar were overbought coincided with the 2022 bear market, and these challenges are once again rearing their heads as the lone purple dot signal. Often, but not always, market turmoil coincided with these overbought signals – the global financial crisis and coronavirus collapse being the two big exceptions. (This disorder was of course due to other causes.)

If these current moves happen, stocks may have already paid enough of a price to continue their upward climb after this “healthy” pullback. But history suggests we are at least a few weeks away from that point.

All of this should give hope to stock bulls that once the current repricing turmoil in bonds and currencies ends, stocks can find their footing again. Eventually, interest rates and the dollar will settle into a new equilibrium, and risk markets can resume being a little riskier (i.e. stock prices rise).

Until then, stocks may face another bout of rough air.