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How dollar strength could mean 'death by a thousand cuts' for stocks

The U.S. dollar is currently perched precariously high versus the Japanese yen (JPY=X), the Chinese yuan (CNH=X), and the British pound (GBPUSD=X), with far-reaching implications for global risk markets.

And with domestic policymakers less likely to flinch in the face of soaring inflation, traders are likening the current market to "death by a thousand cuts."

Though the stories vary country by country, the moves in the foreign exchange market are part of a larger, puzzling narrative confronting investors and vexing traders. At what point, if ever, do global central bankers unite and take a coordinated approach to intervening against the strengthening dollar (a la the 1985 Plaza Accord)? Or will markets continue to discount and reverse the limited, ad hoc actions by foreign monetary authorities until the U.S. Federal Reserve finally reverses its hawkish stance as inflation abates?

Take the yen. After the Bank of Japan (BOJ) intervened Friday to support the domestic currency, the yen is once-again weakening toward the big 150 level versus the dollar. It only took market participants about two weeks to fully reverse a similar, suspected "yentervention" by the BOJ in September.

About half of Friday's move was erased soon after foreign exchange markets opened Sunday evening, highlighting doubt among traders that the move would stick. The BOJ likely liquidated a portion of its $1.2 trillion U.S. treasury holdings to finance the dollar sale on Friday — leading investors to question how many dollars' worth of U.S. bonds would have to be sold to establish a more permanent move in the FX pair.

It was also a big weekend in China, as President Xi Jingping consolidated power at the Chinese National Congress by securing an unprecedented third term. The Nasdaq Golden Dragon China Index (^HXC) suffered its worst day ever Monday — down 16% — as half its constituents were down double digits by end of day. Alibaba (BABA) traded below its 2014 IPO price of $68, Pinduoduo (PDD) finished the day down 26%, and EV automaker Nio (NIO) fell 18%.

Performance of Nasdaq Golden Dragon China Index components on October 24, 2002
Performance of Nasdaq Golden Dragon China Index components on October 24, 2002

While the carnage in Chinese stocks got the headlines, the dollar surged to a record high of 7.33 versus the offshore Chinese yuan (CNH=X), which first started trading in 2011. Chinese monetary authorities allow the offshore yuan to trade within a 2% band of its onshore sibling, which is set — or fixed — daily by the People's Bank of China. The offshore yuan is now stretched to the limit of that band, which could force the hand of monetary authorities there to aggressively devalue the yuan.

Over in U.K., the British are welcoming Rishi Sunak as their third prime minister in two months. The pound has been in the spotlight since it sunk to near-parity with the dollar over a month ago. At the time, traders were offloading cable, which itself was fomenting a massive exit from U.K. bonds — sending interest rates soaring. Facing a pension system on the brink of collapse, British authorities managed to ringfence the situation by buying an unlimited amount of bonds over a short period.

The British bond market intervention has arguably been successful so far, as yields there have stabilized and reversed to the downside. However, the pound is still hovering around 1.10 to the dollar — right where it was before the emergency bond-buying.

This image was created by Yahoo Finance using the Dall-E AI image generator. (OpenAI)
This image was created by Yahoo Finance using the Dall-E AI image generator. (OpenAI)

In the U.S., meanwhile, market participants are hanging on the word of every Fed official and Fed whisperer — quick to pounce on anything resembling an eventual departure from its "hike until something breaks" strategy.

On Friday before the bell, Fed whisperer Nick Timiraos at the WSJ provided some fodder for those waiting for the Fed to lift its foot off the brakes. Those comments teed up San Francisco Fed president Mary Daly, who discussed "stepping down" from the current, aggressive pace of raising 75 basis point per meeting.

While stocks liked the news Friday, which bled into Monday's price action, the larger problems embedded in global bond and foreign exchange markets aren't disappearing. And the biggest headwind toward meaningful rallies in stocks and bonds might just be the extant overall strength in the U.S.

Jared Blikre is a reporter focused on the markets on Yahoo Finance Live. Follow him @SPYJared.

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