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.