EXPLAINER: How the strong US dollar can affect everyone

NEW YORK

The responsibility does not stop.

The value of the US dollar has been falling for more than a year against everything from the British pound across the Atlantic to the South Korean won on the other side of the Pacific.

After rising again on Friday, the dollar is near its highest level in more than two decades against a key index measuring six major currencies, including the euro and the Japanese yen. Many professional investors don’t expect it to subside anytime soon.

The rise of the dollar affects almost everyone, even those who will never leave American borders. Here’s a look at what’s pushing the US dollar higher and what it may mean for investors and households:

WHAT DOES IT MEAN TO SAY THE DOLLAR IS STRONGER?

Essentially, a dollar can buy more of another currency than it could before.

Consider the Japanese yen. A year ago, $1 could fetch just under 110 yen. Now he can buy 143. That’s about 30% more and one of the biggest moves in the US dollar against any other currency.

The values ​​of foreign currencies constantly move against each other as banks, businesses and traders buy and sell them in time zones around the world.

The US dollar index, which measures the dollar against the euro, yen and other major currencies, has climbed more than 14% this year. The gain looks even more impressive compared to other investments, most of which have had a dismal year. US stocks were down more than 19%, bitcoin was down more than half, and gold was down more than 7%.

WHY IS THE DOLLAR STRENGTHENING?

Because the American economy is doing better than the others.

Even though inflation is high, the US labor market has remained remarkably strong. And other sectors of the economy, such as the service sector, have held up well.

This helped offset concerns about the slowdown in the housing industry and other sectors of the economy that do better when interest rates are low. This in turn has led traders to expect the Federal Reserve to deliver on its promise to keep raising interest rates sharply and hold them there for some time, in hopes of knocking down the worst. inflation in 40 years.

Such expectations helped the yield on a 10-year Treasury more than double to 3.44% from around 1.33% a year ago.

WHO CARE ABOUT BOND YIELDS?

Investors who want to get more income from their money. And those juicier U.S. yields are attracting investors from around the world.

Other central banks have been less aggressive than the Fed because their economies appear more fragile. The European Central Bank has just raised its key rate by the largest amount ever recorded, three quarters of a percentage point. But the Fed has already raised its key rate by that amount twice this year, with a third scheduled for next week. Some traders are even saying a gargantuan rise of a full percentage point could be possible, following a hotter-than-expected US inflation report on Tuesday.

Partly because of this less aggressive trend, 10-year bonds in Europe and other parts of the world offer much lower yields than US Treasuries, such as 1.75% in Germany and 0.25 % in Japan. When investors from Asia and Europe buy treasury bills, they have to exchange their own currencies for US dollars. This drives up the value of the dollar.

A STRONG DOLLAR HELPS TOURISTS US, RIGHT?

Yes. American travelers to Tokyo spending 10,000 yen for dinner will use 23% less dollars than a year ago for the same meal at the same price.

With the dollar soaring so far this year against everything from the Argentine peso to the Egyptian pound to the South Korean won, the dollar is going higher in many countries than before.

DOES IT ONLY HELP WEALTH PEOPLE WHO CAN AFFORD TRAVEL ABROAD?

No. A stronger dollar also helps US buyers by limiting import prices and pushing inflation down.

When the dollar rises against the euro, for example, European companies earn more euros on every dollar of sales. With this cushion, they could reduce the dollar price of their products and still earn the same amount in euros. They could also leave the dollar price alone and pocket the extra euros, or they could strike a balance between the two.

Import prices fell 1% in August from the previous month, after falling 1.5% in July, offering some relief from the country’s high inflation. Prices for imported fruits, nuts and some peels fell 8.7%, for example. They are down 3% compared to the previous year.

A stronger dollar can control commodity prices in general. This is because oil, gold and the like are bought and sold in US dollars all over the world. When the dollar appreciates against the yen, a Japanese buyer can get fewer barrels of crude for the same amount of yen as before. This may mean less upward pressure on oil prices.

SO THERE ARE ONLY HIGH DOLLAR WINNERS?

No. American companies that sell abroad see their profits shrink.

At McDonald’s, revenue fell 3% over the summer from a year earlier. But if the value of the dollar had simply remained unchanged against other currencies, the company’s revenue would have been 3% higher. Microsoft, meanwhile, said changes in the value of foreign currencies reduced its revenue by $595 million in the last quarter.

A slew of other companies have issued similar warnings recently, and further gains for the dollar could add more pressure on earnings. According to FactSet, companies in the S&P 500 index derive about 40% of their revenue from outside the United States.

OTHER COLLATERAL DAMAGES?

A strong dollar can put financial pressure on the developing world. Many companies and governments in these emerging markets borrow money in US dollars rather than their own currency. When they have to pay their debts in US dollars, while their own currencies are buying fewer dollars every day, it can create a lot of stress.

WHERE DOES THE DOLLAR GO FROM HERE?

The biggest moves in the dollar may be behind this, but many professionals expect the dollar to stay at least that high for some time.

Tuesday’s US inflation report shocked the market and showed it remains more bullish than expected. This is prompting traders to bet on Fed rate hikes for next year. Fed officials recently reaffirmed their commitment to keep rates high “until the job is done” to break the country’s high inflation, even if it hurts economic growth.

This bias towards even higher rates from the Fed should continue to support the value of the US dollar.

For the dollar to weaken significantly, strategists wrote in a BofA Global Research report, “the Fed needs to be more concerned about growth than inflation – and we’re not there yet.”

This story was originally published September 18, 2022 11:04 a.m.