To what extent is a currency’s appreciation deflationary? As the US dollar has aggressively risen over the past year, questions like that are getting more and more attention from the Fed. Cheaper imports and weakened demand for exports both exert downward pressure on inflation.
Recent Fed minutes – as well as market activity – suggest that the dollar’s appreciation will likely push any rate-hike beyond June. As we move through this earnings season, the vast majority of U.S. companies with international exposure have been hurt by forex shifts. However, they were harmed mainly through devaluation of foreign currency holdings, not forex-driven decreases in demand. As the world adjusts to the new currency environment, weakened demand for U.S. exports looms large.
Considering that a rate-increase will most likely drive the dollar higher, the Fed certainly weigh U.S. exporters’ ability to withstand such a move. Of course, the U.S. economy altogether has far less exposure to exports than the firms that comprise the S&P.
Graph added by the Prof. A higher level represents a stronger dollar. What we’ve seen is a rise from 70 to 90 or about 28%. Alternatively, a 70-unit-equivalent item that used to cost $10 now costs only $7.78.
One Comment
Tradables — manufactured goods, commodities and food — are important though labor remains far and away the greatest cost (70%) for businesses. For example, gasoline is only 5% of the CPI, and food at home 8%. However even for food at home, the price is driven more by labor costs and processing costs than by the actual cost of wheat and corn. So yes, it will have an impact, but a modest one. Meanwhile the impact of any increase in interest rates on the value of the dollar is uncertain, and much trade is under contracts that fix the price in dollars, either directly or through exchange rate futures contracts. So the impact won’t be immediate.
Now the earnings story is different. Profits can go up in each individual national market of a large firm yet accounting profits fall because with a strong dollar those extra RMB and pesos and yen and euros don’t add up as much. Since most companies pay out at best modest dividends, there’s no short-term cash crunch operating there. If prices of international firms traded in the US fall, well, maybe it’s a good time to buy?
Comments are closed.