Dow Breaks From Pattern as VIX Soars?But Why Did the Dollar Budge?
Despite a surprisingly choppy 2022 so far, the Dow broke from its pattern Tuesday as the VIX (CBOE Volatility Index) surged to its highest level in more than a year. The move comes as investors have embraced risk-on sentiment and optimism about China trade talks. It also marks the latest sign that market fear is starting to ripen, following a spike in volatility that reflected worries about rising global debt.
The S&P 500 bounced back above the record-highs posted earlier this month, but investors remain jittery about an escalating debt crisis in Europe and other monetary issues. The Federal Reserve is widely expected to hike interest rates by a hefty 50 basis points at its upcoming meeting, and that, together with ramped expectations of a US budget deficit near or over $1 trillion per year for the foreseeable future, are fueling fears that inflation may return.
On the other hand, core inflation, which excludes volatile energy and food prices, fell in October to its lowest level in nearly a decade. While that is a welcome development for the Fed, analysts cautioned that incoming data could undermine this bullish view.
Aside from a potential weakening of the economy, the dollar’s decline is being driven by private investors in foreign exchange markets and concerns about its role as the world’s dominant currency. Monetary authorities have been increasingly doubtful about the dollar’s long-term stability, and they want to diversify their reserve currencies away from the US.
But a weaker dollar could also deter global growth and hurt the stock market. That’s because a stronger dollar typically means that companies in the United States will pay less for foreign goods and services than they would if they were denominated in a different currency.
This would lower corporate profits, which are a key driver of the economy. It’s a situation that has been exacerbated by China’s trade rebalancing policy, which is boosting exports.
It’s also likely to keep China from ratcheting up its stimulus plans, which would further pressure the dollar. Adding to the concerns is the threat of more instability in Libya, where a bloody revolt has already forced the government to shut down its electricity grid and cut off supplies of the key oil export.
Ultimately, the dollar is probably going to drift lower in the coming weeks and months as governments try to contain their costs without sacrificing economic growth. It’s also possible that the Fed will be more lenient on interest rate hikes and other monetary policies than it has been in recent months.
The SPX and Nasdaq have been in a tight trading range for the past week, and the market has been particularly cautious about letting the VIX get too high. This can be a good sign of investor confidence, but it can also mean the market is getting close to a major top. Should the indices continue to fall, it will be important to watch for a divergence in the SPX and VIX.
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