Financial Professionals

August 15th, 2022

What Does a Strong Dollar Mean for the Markets and Global Economy?

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For any readers considering a trip to Europe sometime in the future, now might be as good a time as any to make your plans. For the first time since 2002, the dollar has strengthened so much against the euro that the two currencies are at parity – meaning they are roughly equal in value. One dollar gets you one euro.1

U.S. Dollar to Euro Exchange Rate

Source: Federal Reserve Bank of St. Louis2

This move to parity comes on the heels of the U.S. dollar strengthening by over 15% relative to the euro year-to-date, as seen in the sharp decline on the chart above. The dollar has also been strengthening against a basket of the broad developed market and emerging market currencies, which has come as the Federal Reserve embarks on a relatively aggressive monetary policy tightening campaign. The U.S. economy is also largely seen as strong relative to Europe and the developing world, particularly as China’s economy slows in response to restrictions tied to its zero-Covid policies. This relative strength encourages foreign investors to invest in U.S.  assets and debt, which generally means using dollars and boosting the greenback in the process.

U.S. Dollar Index Against Developed Foreign Economies

Source: Federal Reserve Bank of St. Louis3

In terms of what the stronger dollar means for markets and the global economy, there is no singular answer. A stronger dollar creates winners and losers, and in that sense, a stronger or a weaker dollar is not inherently negative or positive.

Among the winners are U.S. consumers, and also businesses that rely heavily on imports in order to drive domestic sales. Americans can stretch the value of the dollar when traveling overseas and/or buying goods and services from abroad, and businesses that rely on imports may see some input cost relief given the dollar goes further.

On the flip side, multinational corporations that generate considerable revenue from abroad can see foreign sales take a hit in a strengthening dollar environment. In combing through Q2 earnings reports, we saw quite a few mentions of the stronger dollar impacting foreign sales. Microsoft, for instance, generates most of its profits from overseas ($36 billion abroad versus $35 billion domestically last year), and so a stronger dollar can mean a higher cost for foreigners buying Microsoft products. The company reported a $300 million impact from a stronger dollar in the last quarter. To be sure, however, many multinationals never convert foreign profits back to dollars (repatriation), instead using their earnings to pay for production, costs, and investments in the foreign country where the revenue is derived.

Foreign consumers, the U.S.  tourism industry, and Emerging Markets countries can also be adversely impacted by a stronger dollar. Since a stronger dollar means foreigners have less spending power in the U.S., some may opt not to visit or may spend less when they’re here. That can of course impact hospitality businesses in the US, like hotels, restaurants, and tourist-dependent businesses.

Emerging Markets can also be hindered by a stronger dollar, particularly those countries with high debt-to-GDP ratios and relatively low foreign currency reserves. Since some level of Emerging Market debt is financed in dollars, a stronger dollar means that interest payments are more expensive. That can hurt a country with high debt levels and a non-dynamic economy, particularly those that are commodity-intensive. 

Bottom Line for Investors

The bottom line is what a stronger dollar means for equity markets. The answer, fortunately, is that there are too many other factors driving the equity markets for the dollar to have outsized influence.

To the extent a strong dollar affects earnings, individual stocks can feel an impact. But broadly speaking, the stock market has done very well when the dollar was strengthening and weakening, and vice versa. There is no significant correlation between the two. A strengthening dollar historically corresponded with one of the best periods for stocks, 1995 – 2000, but also one of the worst: the 2008 bear market. At the same time, the dollar’s weakening period from 2003 – 2006 did not adversely impact the economic expansion and stock market recovery then, just like a strong dollar is not likely to shift the economy or market’s direction now. 

Disclosure

1 Wall Street Journal. July 22, 2022. https://www.wsj.com/articles/what-a-strong-dollar-means-for-the-rest-of-the-world-11658482200

2 Fred Economic Data. August 5, 2022. https://fred.stlouisfed.org/series/DEXUSEU#

3 Fred Economic Data. August 5, 2022. https://fred.stlouisfed.org/series/DTWEXAFEGS#

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Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research, analysis, and assumptions. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Clients should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.

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