Analysts are going long on the greenback and here’s why!
The U.S. dollar continues to show signs of strong growth in a global economy that is decidedly weak. Even historically low oil prices have failed to ignite growth in emerging market economies and developed economies, but the U.S. economy soaks it all up and churns out a stronger dollar. The dollar has appreciated by as much as 25% since 2014 and while the effects have not quite filtered down to everyday consumers in the U.S., they will be felt in coming months. As the dollar gains ground, the cost of imports will decrease. This will be felt in the summer months at retailers across the country. This sentiment is shared by the top economists at JPMorgan Chase & Co, Goldman Sachs and Banc De Binary.
Fuel costs are stabilizing in the $50 - $60 price range and consumers have realized strong savings in the form of lower costs at the pump and increased disposable incomes. At the height of the dramatic fuel price drop, middle class Americans were forecast to enjoy savings of up to $125 billion dollars annually according to an article penned by Goldman Sachs (NYSE:GS) analysts. While the figures are not cast in stone, there are ‘conservative’ estimates of up to $100 billion in potential savings during 2015. This together with a stronger dollar is going to push the U.S. economy over the top, ceteris paribus.
The U.S. Dollar Index Economists from Oxford Economics believe that the stronger dollar will serve the U.S. economy well by keeping inflationary pressures in check. For seven consecutive months the cost of all imported goods has been declining, bar February 2015 when the price of crude oil stabilized. By Q2 and Q3 the effects of a stronger dollar will be felt in the U.S. Over the course of the past year, the U.S. Dollar Index (DXY) has reflected a steep increase from a 52-week low of 78.91 to a 52-week high of 100.06. This weighted index is used to compare the strength of the dollar to a basket of currencies including the following: EUR (57.6%), JPY (13.6%), GBP (11.9%), CAD (9.1%), SEK (4.2%) and the CHF (3.6%).
The index was last trading at 99.36 (March 12, 2015), down marginally from the 52-week high as a result of a weak retail-sales report released on the same day. Many different sectors of the economy are benefitting from a stronger dollar, especially retirees and other middle class Americans who can now enjoy greater purchasing power with their greenbacks on overseas vacations. With depressed fuel prices, cost savings will continue and the imminent interest-rate hike will allow Americans to start earning interest on these accumulated savings.
The Effect of a Strong Dollar on Stock Markets and International TradeBased on past trends, the U.S. stock market will likely perform better when the dollar is strong. Multinational conglomerates based in the U.S. will also be eager to snap up relatively cheap overseas investment opportunities as their dollars are now stretching much further against euros, rubles, yen, rands, reals, liras and other currencies. China will likely also be satisfied with a strong U.S. dollar since the country has over $4 trillion in dollar-denominated reserves.
But the flip-side of the coin also holds true and U.S. investors and companies will be taking a hit from their exports. As the value of the USD appreciates relative to foreign currencies, dollar-denominated goods become more expensive. The effect on exports will not be revealed for some time until the upcoming quarterly reports are released. Likewise, foreign investors will be hard-pressed to purchase U.S. stocks on the NYSE and NASDAQ among others. This will largely be offset by the ability of U.S. investors to purchase stocks in other countries across Europe, and in countries like Russia, Brazil, Japan, South Africa.
On the commodities front, prices have been hit hard by a rampant dollar. The DBC (Deutsche Bank (XETRA:DBKGn) Commodities Tracking Fund) is down 35%+ and this is hurting emerging market economies which have their own problems to deal with. With a strong dollar, and strong dollar demand, emerging market economies are hard-pressed to entice international investors. Countries like South Africa, Turkey and Brazil have seen sharp declines in their cross-currency exchange rates of late. Fund managers in South Africa for example have been seeing increased sales of rand-denominated assets in favour of dollar-denominated assets.
This accelerates the dollar surge and drives local currencies lower. With interest rates expected to rise in the U.S. this summer, foreign investors will be snapping up dollars to bolster their financial portfolios. Of equal importance is the negative impact that a strong dollar will have on central banks vis-à-vis trade balances. As governments start eating into their reserves to make up for the shortfall, so added pressures are brought to bear. Foreign currencies are buckling under the pressure with former Soviet states showing the worst depreciations of all.
An Impending Eurozone Crisis on the Cards?The eurozone has enough problems to contend with, without having to worry about a strengthening USD. Presently, the ECB has stepped up to the plate with a massive asset repurchases program to try and stave off deflationary fears and jumpstart the European economy. However with negative interest rates across Europe, and the likelihood of an interest rate hike in the U.S. there will be a massive capital outflow from Europe to the U.S. This will further strengthen the USD by driving up dollar demand and crushing the euro in the process.
With the exception of talks of a Grexit and a Brexit, the euro is teetering. Should the Fed decide to hike the rate in June, the market will react strongly to the announcement on March 18 2015. According to Fed chairman Janet Yellen, the USDs strength coupled with falling oil prices are resulting in inflation falling short of expectations. She added that falling prices are a result of lower energy costs and a stronger dollar. This means that inflation is all but non-existent at this time. It is precisely for this reason that a rate hike would seem disingenuous at this time. Bear in mind that interest rate hikes decrease the velocity of money supply in an economy and low inflation requires precisely the opposite!