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April 1, 2021, 12:34 p.m. EDT

The dollar will keep rising but it won’t be fatal for U.S. stocks, Citi says. Here’s how to play it.

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By Callum Keown

U.S. stocks are starting the quarter in positive territory after President Joe Biden rolled out his $2.3 trillion infrastructure plan. Biden described it as a “once-in-a-generation investment in America” in a speech on Wednesday.

American manufacturers grew faster in March as the key ISM manufacturing index hit a 38-year high, providing further impetus for the stock market.

Investors will be closely the nonfarm payrolls report on Friday, when markets in the U.S. and Europe will be closed for the Good Friday holiday.

The U.S. dollar /zigman2/quotes/210598269/delayed DXY +0.08% also remains in focus, as its recent rebound has raised concerns among stock-market bulls . However, in our call of the day , Citi strategists argued that U.S. stocks may even outperform as the dollar’s rally continues.  

Citi foreign exchange strategists noted that the DXY benchmark — measuring the dollar’s value against a basket of currencies — is up 4% since mid-February and expected the U.S. dollar rally to continue, citing the rapid U.S. COVID-19 vaccine rollout in the near term and higher fiscal stimulus over the medium term.

But the bank’s global equity strategists said that didn’t necessarily mean stocks were set to fall, as history may suggest.

“A stronger dollar can be a brake on risk assets, although is not fatal if the global economic recovery continues,” they said.

Citi’s three-stage “dollar smile” model shows a rising dollar and a slowing global economy in March 2020 and then a falling dollar and expanding economy in the second half of last year. It said it was now time for stage 3, which would see the dollar rise and economy expand.

Stage 1 saw risk appetite drop as markets priced in a global slowdown, with the dollar becoming a safe haven currency, while in stage 2 risk appetite recovered as the economic outlook improved and the dollar dropped back.

“Next the U.S. dollar starts to move back up towards the right of the smile. The global economic recovery continues with the U.S. leading the way. Treasury yields rise further as markets contemplate potential rate hikes from the Fed,” it said. “This strategy is starting to work now,” the Citi team added.

Citi’s strategy for stage 3, which it said was happening now, advises investors to be overweight on U.S. stocks and Japanese equities, if the yen is hedged, but underweight on emerging market and U.K. stocks. When it comes to sectors, the team is overweight on industrials, financials and information technology and underweight on consumer staples, materials and communication services. Investors should also consider taking profits on commodities.

As the dollar keeps rising — to complete the ‘dollar smile’ — it will start to “prove a drag on risk assets,” the team said, adding that it was too early to call the next bear market but that investors should be more careful.

The team said this was a “simplistic strategy” based on previous periods when the dollar was rising alongside an global economic expansion and noted other themes, such as rising bond yields and value rotation that may deliver contradictory messages. “Nevertheless, our analysis should give a good feel for how investors might integrate a rising U.S. dollar into equity portfolios,” Citi said.

The chart

This chart from LPL Financial shows that April has historically been a great month for stocks, in fact it has been the best month over the past 20 years and the second best since 1950. Chief market strategist Ryan Detrick said stocks have closed higher in April in 14 of the past 15 years.

The markets

U.S. stocks /zigman2/quotes/210598065/realtime DJIA -0.56% /zigman2/quotes/210599714/realtime SPX +0.08% /zigman2/quotes/210598365/realtime COMP +0.59% moved higher early on Thursday in the aftermath of Biden’s infrastructure speech and better-than-expected manufacturing data. European and Asian stocks were also buoyed by the infrastructure spending proposal, with Asian indexes making modest gains overnight and the Stoxx 600 /zigman2/quotes/210599654/delayed XX:SXXP +0.70% rising 0.4% in early trading .    

US : U.S.: ICE Futures U.S.
+0.07 +0.08%
Volume: 0.00
Jan. 17, 2022 5:07p
US : Dow Jones Global
-201.81 -0.56%
Volume: 396.47M
Jan. 14, 2022 5:16p
+3.82 +0.08%
Volume: 2.52B
Jan. 14, 2022 5:16p
US : Nasdaq
+86.94 +0.59%
Volume: 3.76M
Jan. 14, 2022 5:16p
+3.35 +0.70%
Volume: 0.00
Jan. 17, 2022 5:50p
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