CEW - Strong dollar is flashing a warning of a credit event - BofA

The recent strength in the U.S. dollar is raising the possibility of a further shock to the economy beyond recession, according to BofA Securities.

The dollar index ( USDOLLAR ) -0.3% is up more than 7% year to date and has broken through parity with the euro ( FXE ) +0.8% as the Fed remains aggressive in its tightening compared to other central banks.

Emerging market currencies ( CEW ) +0.5% have come under extreme selling pressure and that selloff may still have more room to run, according to Wells Fargo.

"In many cases, despite global equities in bear market territory and the risk of a global recession elevated, currencies have yet to approach the upper bound of their segment's potential depreciation range," economist Brenda McKenna wrote in a note Friday.

A spiking greenback often portends a credit event, as it did in 1998, 2008 and 2020, BofA strategist Michael Hartnett wrote Friday in his weekly Flow Show note.

An "intense central bank hiking cycle" is a risk for the current consensus of a shallow recession and "fresh, big rate hikes as central banks play catch up in coming months risks 'recession shock' morphing into credit event (as US$ heavily hints at)," Hartnett said.

Liquidation, deleveraging and default risks are high in areas like private equity and venture capital (see the chart of Softbank credit default swaps at the bottom), he added.

A peak in the dollar in Q3 absent a credit event is the best path for a year-end rally in distressed cyclicals, but investors have to pick which FOMC meeting (Sept. 20, Nov. 1, Dec. 13) to flip their portfolio before, Hartnett said.

We "think Nov unless market melts down next 8 weeks."

For the broader market, BofA still says nibble at S&P 500 ( SP500 ) ( SPY ) 3,600, bite at 3,300 and gorge at 3,000.

See why traders are back in the 75-basis-point hike camp today .

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