U.S. Dollar Reflects Economic Concerns
The U.S. dollar is the world’s de facto currency. It is the most liquid currency and is readily accepted for trade around the globe. In fact, 65 percent of all the U.S. currency printed is located outside the country. 85 percent of all foreign currency transactions involve the U.S. dollar and nearly 2/3 of all known foreign central bank cash reserves are held in the American greenback. In short, the U.S. dollar reigns supreme.
But the U.S. dollar has been in a steady decline this year. After establishing a 14-year high in December 2016, the dollar has plummeted over 10 percent and remains at its lowest levels since January 2015. The benchmark measure for tracking the strength of the dollar is the U.S. Dollar Index, which reflects the performance of the dollar versus a basket of the top six global currencies.
Understandably, most of us aren’t carrying a stash of Japanese Yen or Swedish Krona in our pockets as we wait at the local checkout line. So, what does a weaker dollar really mean?
The strength of the U.S. dollar is based on its relative worth, or purchasing power, compared to other global currencies over time. Simply stated, a strong dollar means one can buy more of a foreign currency than it could before. Conversely, a weak dollar means one can now buy less.
But is a weaker U.S. dollar inherently bad? In reality, there are trade-offs. A weaker dollar makes foreign imports more expensive, which now require more dollars to purchase the goods and services in the stronger foreign currency. As for those overseas vacations Americans love to take, well, that’s now going to cost you a bit more money.
However, the weaker dollar has made U.S. goods cheaper to purchase for overseas buyers, making American manufacturers more competitive. U.S. multi-national corporations, which earn a significant portion of their profits from overseas operations, have been the most visible benefactor. Their overseas profits are valued in the local currency. When converted to dollars, the weaker dollar allows them to retain more of their profits. The continued strength in corporate earnings, boosted by the weaker dollar, has helped drive the stock markets to record highs.
Historically, the dollar tends to follow varying cycles of strength and weakness, but the main factor for its demand is the strength of our economy. Vibrant economic growth typically translates to a rising stock market and higher interest rates, attracting global investors in search of greater returns and yields. A strong U.S. economy offers the perceived safety and stability relative to the uncertainty of many foreign markets. Accordingly, global investors sell off their local currency to buy U.S. dollars to purchase these higher yielding and more stable investments. This drives up the demand and value of the dollar relative to its global peers.
Make no mistake, the U.S. dollar and the American economy still remain a symbol of global economic strength and stability. But given the record pace of the U.S. stock markets, why has the dollar been in such a steady decline since December?
As you might recall, the dollar spiked immediately after President Trump’s election victory. His proposed agenda, fueled by tax cuts, infrastructure spending and deregulation, would finally unleash a robust and inflationary U.S. economy. In response, the Federal Reserve could be more aggressive in its plans to raise interest rates. With the prospects of economic growth and higher interest rates, global demand for the dollar surged.
But much has happened since the election and President Trump’s January 20 inauguration. Infighting within the Republican Party and general mishandlings within the administration have all raised concerns about President Trump’s ability to pass his economic agenda. The global economy, specifically the Eurozone, continues to improve, attracting funds out of the U.S. markets into countries with declining risk and rising returns. Finally, the American economy faced with moderate growth, low inflation and stagnant wage growth, has cast serious doubts on future rate hikes.
Despite its recent decline, the U.S. dollar certainly remains the most powerful and strategically important currency in the world. Nonetheless, the pullback does represent the ongoing economic and political concerns of the country. The Fed and the White House continue to tout that greener pastures are around the corner; but, clearly the global market’s patience has run thin. Markets aren’t driven by rhetoric, but instead by the conviction of traders and investors who put their own capital at risk. And for now, the decline in the U.S. dollar continues to reflect those concerns.
Mark M. Grywacheski, Investment Advisor
Opinions expressed herein are subject to change without notice. Any prices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given price. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets, or developments mentioned.
Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
