The Strong Dollar: A Too-Rapid Rise Could Harm the Economy
New York (Oct 4) As in those old Charles Atlas ads that promised strength in order to keep from getting sand kicked in your face, the dollar has recently bulked up from a 100-pound weakling into a muscle-bound stud. Has the greenback become the new bully on the block?
Consider: The U.S. Dollar Index, which tracks the buck’s strength against the euro, yen, and other currencies, gained 7.7% during this year’s third quarter. Ignore the third quarter of 2008, when the dollar was about the only safe asset out there amid the ruins of the global financial system, and you have to go back to 1992 to find a bigger quarterly gain.
Now, a strong dollar has its advantages. When the greenback goes up, stuff bought with it gets cheaper—one reason oil and gas prices are plunging. And that should leave your average American with more to spend on toys like boats, clothes, and gigantic television screens. But if the dollar rises too quickly, it could create head winds for the U.S. economy and its corporations that could upend much of the progress that’s been made since the financial crisis.
WHAT’S THE SECRET to the dollar’s sudden strength? Currency is a relative game, and to buy the greenback, people must sell something else, say the euro or the yen. And for the most part, two factors determine what people want to buy or sell: the strength of an economy and the direction of its interest rates.
Now the U.S. economy might not be expanding very fast—gross domestic product is expected to rise just 2.1% in 2014—but it’s growing fast enough that the Federal Reserve is one of the only major central banks even contemplating a rate hike. That’s made the greenback the popular kid on the block. “There’s a lack of opportunity outside the dollar,” says Société Générale strategist Sebastien Galy.
A heavy-duty dollar doesn’t have to mean trouble. From June 1995 to June 2001, the greenback soared 46%, propelled by a booming economy, while the S&P 500 more than doubled. The dollar also surged 78% from June 1980 to December 1984 as Fed Chief Paul Volcker, who was trying to kill inflation once and for all, hiked short-term rates so high they got altitude sickness. The S&P 500 gained 46% in that stretch.
But even a muscle-bound meathead could tell that current conditions don’t quite resemble what prevailed in those periods. Consumer prices, for instance, rose just 2.1% from the year-earlier level in the second quarter, and inflation expectations have plunged during the past month as investors wrestle with the implications of possible rate hikes and the stronger dollar. And even if the economy keeps improving—it’s expected to grow at a 3% clip next year—that’s still a far cry from the supercharged growth of the 1990s. Worse yet, the stronger buck could make even hitting that target difficult because it would make American exports more expensive—and less attractive.
“I’m not sure we want to worship at the altar of a strong dollar,” says MKM Partners strategist Michael Darda. “You have to be careful what you wish for.”
If the dollar is the bully, then the stock market is the wimp getting sand kicked in its face. The S&P 500 has dropped 2.8% during the past month, as the dollar’s rise accelerated—and why not? These days, companies in the S&P 500 get about a third of their revenue overseas, and those sales are worth less when converted into a stronger dollar. A rising buck also makes products priced in the U.S. currency comparatively expensive against imports—suddenly cars made by Ford Motor (ticker: F) and General Motors (GM) would be at a competitive disadvantage to those made by Toyota Motor (TM) and other foreign manufacturers. It could also force American companies to cut prices outside the U.S., putting pressure on record-high profit margins.
We’ll see the impact of the dollar’s rise when companies start reporting third-quarter financial results later this month. Barclays strategist Jonathan Glionna says that the stronger dollar could shave close to a half-point off quarterly revenue growth, causing more companies to miss their earnings and revenue forecasts than was the case in recent quarters. “When the dollar rises slowly and gradually, it gets fully reflected in estimates,” he says. “When it happens quickly, estimates don’t react, and companies can miss estimates.”
BUT THE STRONGER GREENBACK could aid companies that generate most of their revenue in the U.S. and source materials overseas. Wells Fargo analyst Gina Martin Adams identifies the U.S. companies that have been most closely linked to the dollar during the past five years. They include burglar-alarm provider ADT (ADT), paint manufacturer Sherwin-Williams (SHW), and biotech giant Amgen (AMGN).
Source: Barrons
