Why Is The U.S. Dollar So Strong Right Now?
Nearly every asset class has seen miserable returns in 2022, except for the United States dollar.
The dollar has strengthened dramatically over the course of the year as the Federal Reserve hiked interest rates in an effort to quash sky-high inflation. The U.S. Dollar Index, which measures the greenback against a basket of other currencies, is up nearly 17% so far this year.
“We have seen a tremendous rise in the dollar,” said Matt Forester, chief investment officer of Lockwood Advisors at BNY Mellon Pershing. “It’s a juggernaut in the middle of every securities transaction and payment around the globe.”
The dollar’s strength is even more pronounced when compared to the poor performance of stocks, bonds, real estate and cryptocurrencies—and that’s before considering the impact of inflation. Moreover, a strong dollar benefits American consumers who buy foreign goods (hello, French wine!)
But the strong dollar story is not entirely positive, especially for your investment portfolio. Here’s what you need to know.
What Does a Strong Dollar Mean?
A strong dollar refers to the relative value of dollars compared to another currency or a basket of currencies. A currency isn’t strong or weak on its own; it can only be so compared to something else.
The U.S. dollar is strengthening because the Fed adopted a hawkish monetary policy stance in response to skyrocketing inflation. It has lifted the federal funds rate from near zero at the beginning of 2022 to a range of 3.0% and 3.25% at the September FOMC meeting.
Market observers expect at least another percentage point increase, if not more, by the end of the year.
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But the strong dollar isn’t just about the Fed. While the U.S. economy may be flirting with a recession, it’s still looking much better than other advanced economies, including the United Kingdom, European nations and Japan.
European economies are bearing the brunt of Russia’s war on Ukraine, especially in the form of dramatically higher energy costs. Japan is struggling with lower global demand for manufactured goods, which make up the better part of its exports.
Meanwhile, the sheer tonnage of geopolitical risks swamping the global economy, not least of which are China’s economic troubles thanks to its zero Covid policy and bursting real estate bubble, have driven investors to safe-haven investments. And the greenback is currently one of the safest bets around.
When global investors pour money into U.S. dollars, they are selling off other currencies. Buying dollars pushes up the value of the greenback, and selling other currencies weakens their value.
American consumers are clear beneficiaries of the trend. Any imported goods or services purchased in euros, pounds or yen is now significantly cheaper than a year ago, a welcome development for consumers who are already struggling under the yoke of high prices at home.
“The strong dollar is providing an offset to inflationary pressures which we’ve seen via improving consumer spending,” said Argent Financial Group chief investment strategist Tom Stringfellow.
How Strong Is the Dollar?
Using a comprehensive metric like the U.S. Dollar Index gives investors and consumers insight into the dollar’s strength vis-a-vis a basket of currencies.
But many folks, especially those wanting to know where to book their next vacation, want insight into how strong the dollar is compared to specific currencies.
Here’s a view of how the dollar compares to major currencies as of Sept. 28, 2022:
- EUR/USD: One euro buys $0.97 today, compared to $1.17 a year ago
- USD/JPY: One dollar buys 144.18 yen now, versus 111.54 a year ago
- USD/CHF: One dollar buys 0.98 Swiss francs today, compared to 0.93 a year ago
- GBP/USD: One British pound buys $1.09 now, compared to $1.37 a year ago
- USD/CAD: One dollar buys C$1.36 now, versus C$1.26 a year ago
In each of these pairs, the dollar is in a stronger position now that it was 12 months ago, to the delight of American consumers.
American exporters, though, aren’t happy.
“The dollar is almost the strongest in two decades against the euro, putting American manufacturers at a pricing disadvantage against many foreign competitors,” said Bill Adams, chief economist for Comerica Bank. “The Chinese yuan has depreciated sharply since early 2022 as well as the tech industry correction, restrictions on movement, and a housing correction weigh on its economy.”
How the Strong Dollar Impacts Investors
Volatility in the currency market has important implications for investors. Take Microsoft Corp. (MSFT), the world’s third most valuable company by market cap.
This tech behemoth recently warned analysts and investors that future revenue would drop even more than expected thanks to a rising U.S. dollar. How can this be?
Microsoft is a multinational corporation that takes in roughly half of its revenues in foreign currencies. If the value of the money it earns abroad falls compared to the dollar, that means Microsoft will earn less in U.S. dollars for those sales.
Companies that depend on exports from the U.S. for their sales or earn a lot of revenue overseas could struggle in a strong-dollar environment. This could put even more pressure on their shares, which are already dealing with higher interest rates and domestic consumers suffering from high inflation.
Microsoft is down roughly 29% so far this year, compared to a 24% decline for the market as a whole.
Emerging markets are also struggling, with diversified emerging markets funds down 27% so far this year.
That’s because many of the countries issue dollar-denominated debt and then service those IOUs with their respective currencies. That’s a tough bargain when the dollar is strengthening and interest rates are rising, potentially leading to losses and defaults.
What Can Investors Do About the Strong Dollar?
There are some strategies that allow individual investors to hedge against currency volatility, but they tend to be very complicated and expensive.
Average traders need to be cognizant of global events in order to understand why their portfolio may be struggling at a particular moment.
“More U.S. investors and advisors need to be paying a lot closer attention to what’s going on in the world,” said Forester. “It’s going to have an effect on your portfolio.”