The value of the US dollar has been on a tear against everything from the British pound across the Atlantic to the South Korean won across the Pacific for more than a year.
After rising again on Friday, the dollar is near its highest level in more than two decades against a major index measuring six major currencies, including the euro and the Japanese yen. Many professional investors don’t expect this to be easy anytime soon.
Dollar growth affects almost everyone, even those who will never leave US borders. Here’s a look at what’s propelling the US dollar and what it could mean for investors and families:
What does it mean to say that the dollar is strong?
Essentially that one dollar can buy more currency than before.
Consider the Japanese yen. A year ago, $1 could fetch a little less than 110 yen. Now, it can buy 143. It is up almost 30% and is one of the biggest moves the US dollar has against another currency.
Forex prices are constantly shifting 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 gains look even more impressive compared to other investments, most of which have had a disappointing year. US stocks are down more than 19%, bitcoin is halving and gold is down more than 7%.
Why is the dollar strengthening?
Because the US economy is doing better than others.
Although inflation is high, the US job market remains remarkably solid. And other sectors of the economy, such as the services sector, have been resilient.
This has helped allay concerns about a slowing housing industry and other parts of the economy that do best when interest rates are low. Traders, in turn, expect the Federal Reserve to follow through on its promise to raise interest rates sharply and keep them for some time in hopes of reducing inflation to the worst in 40 years.
Such expectations have helped propel the 10-year Treasury yield to 3.44%, more than doubling from about 1.33% a year ago.
Who cares about bond yields?
Investors who want to make more income from their money. And those juicier US yields are attracting investors around the world.
Other central banks have been less aggressive than the Fed because their economies seem more fragile. The European Central Bank has raised its key rate by the largest amount ever, by three-quarters of a percentage point. But the Fed has already raised its key rate by that amount twice this year, with a third expected this coming week. Some traders even say that after Tuesday’s warmer-than-expected report on US inflation, a massive increase of a full percentage point may be possible.
Partly because of that less aggressive inclination, 10-year bonds across Europe and other regions of the world offer much lower yields than US Treasuries such as Germany’s 1.75% and Japan’s 0.25%. When investors from Asia and Europe buy Treasuries, they have to trade their currencies for the US dollar. This pushes up the value of the dollar.
A strong dollar helps American tourists, doesn’t it?
Yes. American travelers in Tokyo who spend 10,000 yen on dinner will use up to 23% fewer dollars for a similarly priced meal than they did a year ago.
With the dollar rising so far this year, from the Argentine peso to the Egyptian pound to the South Korean won, the dollar is moving further in many countries than before.
Does it only help rich people who can afford to travel abroad?
No. A stronger dollar also helps US buyers by keeping a lid on prices for imports and pushing downward on inflation.
When the dollar is rising against the euro, for example, European companies make more euros for every $1 of sales. With that cushion, they could cut the dollar price for their products and still make the same amount of euros. They may leave the price in dollars alone and pocket the extra euros, or they may find some balance of both.
Import prices fell 1% in August from a month earlier, after a 1.5% decline in July, offering some relief amid the country’s high inflation. For example, the prices of imported fruits, nuts and some peels declined by 8.7%. They are down 3% from a year ago.
A stronger dollar can generally keep prices under control for commodities. This is because oil, gold and others are bought and sold in US dollars around the world. When the dollar rises against the yen, a Japanese buyer can get fewer barrels of crude for the same number of yen as before. This could mean less pressure on oil prices.
So there are only winners from a strong dollar?
No, US companies selling overseas are seeing their profits shrink.
At McDonald’s, revenue declined 3% during the summer compared to a year ago. But if the dollar’s value had remained the same against other currencies, the company’s revenue would have been 3% higher. Meanwhile, Microsoft said changes in foreign currency values reduced its revenue by $595 million in the latest quarter.
A string of other companies have made similar warnings recently, and further gains for the dollar could put more pressure on profits. According to FactSet, the companies in the S&P 500 index derive approximately 40% of their revenue from outside the United States.
Any other collateral damage?
A strong dollar could put financial pressure on the developing world. Many companies and governments in such emerging markets borrow money in US-dollar terms instead of their own currencies. When they have to pay off their debt in US dollars, while their own currencies buy fewer dollars day by day, it can create a lot of stress.
Where is the dollar going from here?
The dollar’s biggest move could be behind it, but many pros expect the dollar to hold higher at least for a while.
Tuesday’s report on US inflation shook the market and showed it remains more stubborn than expected. This has led traders to bet on a Fed rate hike next year. Fed officials have recently been busy reaffirming their commitment to keeping rates high “until it’s done” in breaking the country’s high inflation, even if it hurts economic growth.
The bias towards higher rates still higher by the Fed should continue to offer support for the value of the US dollar.
For the dollar to weaken meaningfully, strategists wrote in a BofA Global Research report, “the Fed must be more concerned about growth than inflation – and we are not there yet.”
This story has been published without modification in text from a wire agency feed.
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