As many of us have seen, the United States dollar has been strengthening in relation to many of the other global currencies. Typically, when people see the dollar strengthening, they take this as a good thing. To be honest, there are quite a few positives, but in contrast, there are areas on the global scale that can be negatively affected by a strong dollar.

Many may ask, what drives the U.S. dollar to either strengthen or weaken? There are many factors that attribute to these fluctuations which include: Supply and demand, sentiment and market psychology as well as technical factors.

As the United States exports its goods and services, it creates a demand for U.S. dollars for other countries and currencies because customers need to pay for these exports in U.S. dollars. Those countries will have to exchange their local currency into dollars, which means they sell their local currency to buy dollars to pay for U.S. goods and services. Also, when U.S. companies and governments issue bonds to raise capital and they are purchased by foreign investors, those funds also need to be converted and paid in dollars. These are examples that we have seen in the past year which puts constraints on the supply of dollars while the demand for dollars increases simultaneously. Since we have been in a time of global economic uncertainty a lot of foreign investors considered the U.S dollar as a safe haven. On top of that, higher interest rates usually support the dollar by making U.S. assets more attractive to yield-seeking investors. The Federal Reserve has started its interest rate hikes earlier and more aggressively than other central banks across the globe.

As noted above supply and demand drive the dollar but another variable that is important to consider is the sentiment and market psychology behind the value of the dollar. The U.S. relative to its peers has had a strong economy in recent months which drew in foreign investors, in contrast when the U.S. economy weakens and the psychology of investors shifts, you will see investors selling U.S. equites and bonds and return cash into their local currency. This creates a heightened supply of the U.S. dollar which drives the value downward. This is usually coupled with technical factors such as data for gross domestic product (“GDP”), unemployment, payroll and many other statistics that give investors insight on where the dollar may be heading.

After touching on what drives the dollar to rise or fall, we can ask who might benefit from a strengthening U.S. dollar?

  • U.S. Manufacturers – specifically the ones that purchase parts to aid in their production process from outside the United States will usually pay less for these parts when the dollar is strong.
  • Non-U.S. Companies – when selling goods and services to the United States this will ramp up higher demand while prices are now competitively priced.
  • U.S. Citizens – who buy foreign goods and services at a competitive price, as well as travel abroad, where they see the dollar going further towards hospitality, food and recreational activities.
  • Non-U.S. investors – Returns captured in the U.S. stock market will be in U.S. dollars, boosting their overall portfolio returns versus their local currency.
  • Imports – Goods produced in foreign countries where the manufacturer’s currency falls in value   will be cheaper. As the dollar continues to strengthen, the price of imports will continue to fall over time. Also, U.S. companies that purchase raw materials from abroad will have lower costs of production boosting profit margins.

Another question to ask is, who might be negatively affected by a strong U.S. dollar?

  • U.S. Companies – more specifically the companies that have much of their goods and services sold abroad, making their price on products more expensive and less attractive.
  • Non-U.S. Manufacturers – that rely on U.S. made products and services as a part of their business process/model. The products they routinely buy from the U.S. are now more expensive and will reduce the company’s profit margins.
  • Tourism to U.S. – Visitors from abroad will find that traveling to the United States will be more expensive for goods and services when there is a strong dollar.
  • U.S. Exports – Although imports become cheaper, our goods produced domestically become more expensive abroad which can lead to less demand.

There will always be fluctuations in currencies, but ultimately, they usually revert to the mean. This is simply because expensive domestic export prices will have to decrease for those items sold abroad to match demand, and in contrast, cheap imports of foreign goods will increase in price with the elevated demand.

 

Frankie Ramos Jr.
Financial Analyst

Disclosures:
There is no guarantee investment strategies will be successful. Investing involves risks including possible loss of principal. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.
All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their wealth advisor prior to making any investment decision.