by Blaine Dickason
Senior Vice President, Trading and Fixed Income Portfolio Management
The U.S. government has endorsed a “strong dollar” policy for much of the last thirty years. Besides sounding much better than the alternative, this messaging has reminded markets that the U.S. dollar remains the world’s reserve currency, despite frequent projections of its demise or threats to its dominance. The Federal Reserve’s current fight against inflation has elevated interest rates at the fastest pace since the 1980s and has strengthened the dollar versus other global currencies. Global instability, as evidenced by the war in Ukraine and slowing global economies, has also increased the demand to hold dollars. While issuing the effective reserve currency of the world bestows what’s known as an ”exorbitant privilege” on our economy, a rapid rise in the relative value of the U.S. dollar is not all positive for the U.S. or foreign markets.
While it’s pleasant to consider international travel becoming less expensive, the simplest dynamic to a stronger dollar is its effects on demand for imports and exports. Foreign-made goods become cheaper for U.S. consumers because they require fewer dollars to purchase. Conversely, exporters and multinational companies will likely experience lower demand as foreign purchasing power declines. It may not feel like it this year, but a stronger dollar helps blunt inflationary pressures for Americans while accentuating the inflation felt by the rest of the world. To quote former U.S. Treasury Secretary John Connally (1971-1972) in a speech to G10 finance ministers in Rome, “The dollar is our currency, but it’s your problem.”
Source: Bloomberg
A significantly stronger dollar can also affect investment results and performance. Companies with a more significant percentage of domestic production and revenues are more insulated from currency swings, less subject to diminished demand from foreign buyers and less likely to experience a decline in their financial results. Export-oriented companies suffer from the opposite effect, which can be further exacerbated if their costs are denominated in dollars. In addition, dollar-denominated investment returns can dramatically underperform their local currency counterparts. As seen this year, the MSCI All Country ex-US Index is down roughly 15% in local currency but down over 26% when converted back into U.S. dollars.
A strong and rapidly increasing U.S. dollar is a mixed blessing for both consumers and investors. As long as the Federal Reserve is on a path to increase or maintain higher interest rates to combat inflation, the current environment of dollar strength is likely to continue; however, the rate of change may subside. Global central banks may need to increase their interest rates to “tamp down” their domestic inflation while simultaneously defending their currency against a rush to the U.S. dollar. Yesterday’s worse-than-expected September Consumer Price Index (CPI) report did not deliver the results needed for the Federal Reserve to begin backing off their projected rate hikes through the end of the year. Americans traveling abroad may still have time to benefit from this historic period of dollar strength.
Takeaways for the Week
Yesterday’s September consumer price index (CPI) report delivered a clear “Bad News is Good News” moment, as the S&P 500 rallied over 5% off its intraday low and closed +2.6% on the day
The Social Security cost-of-living adjustment (COLA) for the current year was reported yesterday at +8.7%, following a +5.9% increase last year, which had been the highest increase since 1982