As earning season gets closer, talk of those fears has picked up and is spreading across financial markets. Earnings are expected to be negative for the first time since 2009 in the first quarter, with an estimated 3.1 percent decline in S&P 500 net income, according to Thomson Reuters. That theme—highlighting shrinking profits versus high valuations—could continue Wednesday, as traders also position for the approaching end of the first quarter.
"It's a phobia, but I think it's a legitimate one. That's the key to what was driving the market today," said JonesTrading's chief market strategist, Michael O'Rourke. The dollar has gained more than 7.5 percent year to date, in a rapid run that reversed last Wednesday after the Fed released forecasts for a slower path of tightening.
O'Rourke said the stronger dollar is a form of "tightening" on corporate America, as companies react to the revenue hit. The decline in corporate profits is largely the result of the double whammy from the rising dollar and the steep decline in oil prices, expected to be a heavy weight on energy company profits. The second quarter is also expected to be negative.
Markets are also bracing for end-of-quarter portfolio maneuvering, and O'Rourke said it appeared a large asset allocation program helped drive buying in Treasurys as stocks sold off Tuesday. The Dow was down 104 at 18,011, and the S&P 500 fell 12 to 2,091.
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There are few catalysts for markets Wednesday, with just durable goods on the economic calendar at 8:30 a.m. ET. There are a couple of earnings reports including Paychex, Apollo Education Group, Leidos and Yingli Green Energy before the bell. PVH, Red Hat, Five Below and Worthington Industries report after the bell.
Traders will also be watching a $35 billion five-year Treasury auction at 1 p.m. The yield on the 10-year Treasury on Tuesday moved as low as 1.86 percent, after breaking through the technically significant 1.89 percent level.
John Briggs, head of cross-asset strategy at RBS, said worries about corporate earnings spilled into the Treasury market, but the market also continues to price in a slower Fed tightening cycle. "I think it's too rich," he said of the bond market. "I think the market is pricing out too much of the odds of June," for the first Fed rate hike.
By RBS' calculations, the market expects a less than 1 in 5 chance for a June hike, and for September, it sees a 75 percent chance, he said.
"It's overreacting in all directions. Is the Fed going to go in June or September? It depends on the data. I can make a case where they go in June. I can make a case where they can go in September, and I can make a case where they can go in December," he said.
Buyers have also been adding to Treasury positions because U.S. securities are more attractive than other sovereigns, thanks to some central banks easing as the Fed moves toward tightening. For instance, the German 10-year bund was yielding 0.20 percent Tuesday.
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"It's kind of like one beast is feeding the other," said Boris Schlossberg, managing director, foreign exchange strategy at BK Asset Management. "What's happening is the markets are worried the strong dollar is going to depress earnings in equities. ... Every rally in equities keeps failing, and whenever that happens dollar-yen reacts negatively. You're getting this cycle that's kind of been happening here for the last couple of days. You're getting safe harbor funds into bonds, out of the dollar and into yen. The classic risk aversion trade is reasserting itself."
Some strategists expected the dollar to continue a short-term correction after the Fed announcement last week, but ultimately its uptrend should continue.
"I still think the dollar is in a corrective phase. I think the euro tested $1.10, got spanked back because we had decent CPI, and may come back tomorrow to take on the $1.10 again," Schlossberg said.