Fears are growing that market volatility could continue long into the summer as the slide in the US dollar starts to hit earnings at some of the FTSE 100's biggest stocks.
The 10 per cent depreciation in the dollar since the start of the year is now ringing alarm bells among market commentators. Some of the FTSE's biggest companies, such as BP, Royal Dutch Shell and HSBC, all report earnings and pay dividends in dollars. And many of the index's best performers of recent years, including those exposed to the buoyant commodity sector, are also exposed to the dollar through their large international businesses.
"It's generally the case that episodes of dollar weakness lead to weak equity markets," said Anais Faraj, global strategist at Nomura. "This is not just in the UK, it's a global phenomenon."
He believes FTSE 100 movements this summer may be similar to the experience of 2002 and continue to drift south, if not at such a steep rate. Despite domestic economic growth, the FTSE 100 dipped by almost a third to 3,671 in 2002 following the dollar's 13 per cent slide.
"The reason for this is that most international companies deal in dollars," added Mr Faraj. "With the pound at just under $1.90 [against the dollar], company earnings that have done well overseas in the past will fall when translated back into pounds. Companies that report earnings in dollars will become less competitive because the cost of the UK base will increase."
Investors' payouts are also on the line. In 2002, the falls in the dollar led to a 5 per cent decline in dividend payments.
At the moment, the dollar is being hit by cyclical and structural issues. While investors were prepared to ignore America's spiralling current account deficit in 2005, a recent G7 meeting brought the issue back into the spotlight. The US is also nearing the end of its interest rate tightening cycle, with bond and currency investors looking elsewhere for higher yields.
And, with no catalysts in sight for transforming the dollar's fortunes, this state of affairs may last beyond the summer and well into 2007. "It may hit $2 [to the pound] in 2007 but it's unlikely at the moment," said Gavin Friend, a currency strategist at Commerzbank. "However, sterling, the euro and Swiss francs are all building a base for further runs at the dollar."Reuse content