U.S. Dollar Strength the Real Threat to Investors, Not Higher Interest Rates

US Dollar strengthThere are issues brewing in the stock market with interest rates fears and the strengthening greenback that could drive the S&P 500 lower by five percent or more.

When Will the Fed Increase Interest Rates?

First, we have the fears surrounding rising interest rates after the strong improvement in the unemployment rate to a pre-recession low of 5.5%. This is well below the target, previously set by former Federal Reserve chairman Ben Bernanke, as the level at which the central bank would begin raising interest rates.

Although we are well below Bernanke’s set level, the current Fed chairman, Janet Yellen, appears to be showing more patience. My feeling is that the central bank will likely increase interest rates by its June meeting, should the unemployment rate and job numbers remain strong in the months prior.

Why Increased Interest Rates Alone Likely Won’t Affect Stocks

Some would argue the higher interest rates are bad for the stock market, but my feeling is that it all depends on the increase and how fast interest rates rise. I believe the Fed will likely start with an interest rate hike of 25 basis points to gage the market’s reaction before considering moving higher. If the Fed were to surprise the markets with a 50-basis-point rise, that would be a killer.

10 year US treasury Yeild EOD Index

Chart courtesy of www.StockCharts.com

With a simple 25-basis-point rise, I don’t see interest rates having a major impact immediately on the stock market and bond yields. A jump in the 10-year bond yield to above three percent, however, would hurt stocks, as investors would start shifting some capital out of stocks and into bonds.

At the end of the day, I would still rather have slightly higher interest rates, as long as the economy grows and jobs are created.

But here’s the problem…

Strengthening Greenback the Real Threat to Economic Growth?

We are seeing a surge in the U.S. dollar against the euro and other major trading currencies, such as the pound and Canadian dollar. The greenback is closing in on parity against the euro, nearing its strongest level since 2003. The greenback is also up more than 25% versus the Canadian dollar since its low.

Euro Philadelphia INDX

Chart courtesy of www.StockCharts.com

Amongst traders, the concern is that the surge in the greenback makes American goods and services more expensive for other trading partners. As such, a strong U.S. dollar can negatively impact exports, corporate profits, and gross domestic product (GDP) growth going forward. The big U.S. multinationals will likely see less demand for goods around the world, which will surely hit their bottom-lines.

With the greenback moving towards parity with the euro and the likelihood of higher interest rates by June, I envision some growth issues down the road for the stock market.

I would be looking to dump some positions, especially with the large multinationals. In the near-term, I would also be on the watch for additional stock market weakness, which could provide a potential buying opportunity.