The Fed recently released its Beige Book that reviewed the current economic situations across 12 Federal Reserve Districts. The reporting period (between mid-August and October) showed "moderate expansion in economic activity" and remained "generally optimistic about the near-term outlook."
Manufacturing and tourism, however, remained sluggish in certain districts, owing to the strong dollar. New York, Kansas City and Dallas Districts witnessed "weakened" tourism with the rising dollar affecting regions of New York, Minneapolis and Dallas.
Since the middle of last year, the value of the dollar has been strengthening. It's now worth 1.12 euro, 1.31 Canadian dollars and 120.4 Japanese yen -- all much more than a year ago.
Even though the appreciation of U.S. dollar against other currencies may be good news for U.S. consumers (as it makes foreign goods and foreign travel cheaper), its effects on corporate earnings and stock markets can be mixed. In the long run, a strong dollar affects inflation, net exports, eventually acting as a drag on the entire economy. Due to these effects, the Fed's interest rate decision, which can impact the strength of the dollar, will also be about the dollar.
Understanding the dollar's rise against other currencies can help one to identify the potential impact on the value of one's portfolio and the related changes in future investment strategy.
1. Corporate Earnings and Sales
The rising dollar adversely affects those companies that have huge global presence as they end up trading in weakened domestic currency. Such companies mostly rely heavily on the prices of commodities (like energy and materials companies). A strong dollar decreases the foreign demand for U.S. products , as they become more expensive.
The effects of the low demand and high prices together affect sales, which is captured in the low earnings of companies with large foreign exposure. In other words, the exchange rate may negatively influence companies that have closer ties in foreign markets by lowering the company's sales and profits.
Interestingly, an article in the Harvard Business Reviewmaintains that the "truly global U.S.-based" companies involved in exports do not produce in the U.S. but across the globe and hence, their production costs may be little affected by the strong dollar. But, almost half of all revenue for companies in the S&P 500 comes from outside the U.S., mainly Europe and Asia. Such earnings may depend on "how much U.S. companies sell at home and how much abroad," according to Financial Times.
The impact of a strong U.S. dollar against other currencies has already reduced PC shipmentsto regions of Europe, Japan, Africa, Latin America and the Middle East. According to Gartner, "The global PC market has experienced price increases of around 10 percent throughout the year, due to the sharp appreciation of the U.S. dollar against local currencies."
The international operations of Walmart, the world's largest retailer by revenue, faced similar challenges due low sales. According to Reuters, Walmart said that "its current full-year sales would be flat due to the stronger-than-anticipated impact of the dollar."
The currency has also taken a toll on the sales of the healthcare and consumer products giant, Johnson & Johnson, which, like many multinationals earns its revenues in the weaker currencies. The company's revenues were below expected, falling 7.4%.
According to the Financial Times, Mike Mack, the chief executive of the Swiss agribusiness Syngenta said that the dollar would continue to influence the company's performance for the entire year. The firm's third quarter sales had been affected by the strong dollar, forcing the company to report a fall in earnings.
2. The Stock Markets
As reported by the Financial Times, Hamish Pepper, currency strategist at Barclays is of the opinion that the relationship between the S&P 500 and dollar movements is not "consistent." But he further added that information technology, materials, energy and industrials derive about half their sales from abroad.
The stock markets usually capture the dollar effect once corporate earnings are announced. But since the stock market is forward looking, the stock prices also depend on market expectations about the future earnings of the firm. Such expectations are based on a number of factors like sales growth, global outlook, competition, profit margins, etc.
Hence, the stock prices reflect the deviation of actual earnings from the market's expectations of earnings and tend to adjust accordingly. In cases where the deviations of actual earnings from the market's expectations are high, markets may see earning surprises that may be either negative (when actual reported earnings are significantly below the forcasted earnings-per-share) or positive (when actual reported earnings are significantly above the forcasted earnings-per-share).
In January 2015, the Wall Street Journal reported how stock markets dropped as the rising dollar took a toll on growth and sales. In February 2015, two soda giants Coca-Cola and Pepsi were hurt by the rising dollar, since half of their revenues were dependent on the foreign demand.
Besides the price, the strength of the dollar also affects the returns on existing investments of investors. Those who have invested heavily in foreign markets (e.g. foreign stocks or bonds) may find their returns losing value once converted into U.S. dollars.
3. The Fed's Decision
On June 17, 2015 in a press conference, Fed Chair Janet Yellen said that the strong dollar "had a negative effect on net exports and so served as something of a drag on the economy, and probably that drag is going to continue for some time to come. So it is a factor affecting the outlook."
The movement of the dollar can cause huge trade imbalances of an economy. More demand for cheaper imports can threaten the domestic manufacturers. The local manufacturers, who may not have much international presence may face competitions from affordable imports and try to restrain their own costs of production.
The strong dollar may remain a concern in the upcoming meeting of the Federal Open Market Committee on Oct. 27-28. Such concerns with additional factors like low inflation, emerging markets slowdown and weak jobs report may surely influence the timing of the interest rate intervention by the Fed.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.