The short version
- This summer, the U.S. dollar reached a 20-year high and hit parity with the euro.
- Rising Fed rates and concern about geopolitical turmoil, such as to the war in Ukraine and energy crisis in Europe, all contributed to the high.
- The strong dollar is great for inflation, Americans traveling abroad, and foreign companies who have a U.S.-presence, but U.S. companies have warned that it’s impacting their earnings.
Why is the US dollar so strong?
The U.S. dollar rose above nearly all other forex over the last few months. The U.S. Dollar Index (DXY) is the highest it’s been since 2002. In fact, the dollar reached parity with the euro for the first time in two decades over the summer.
The U.S. dollar is so strong largely due to two factors — rising Federal Reserve interest rates and geopolitical uncertainty in the rest of the world.
The Fed aggressively raised interest rates in a bid to tackle skyrocketing inflation. As a result, investors find it more appealing to hold investments in dollars as opposed to other currencies like the euro, Japanese yen or Sterling.
And while there’s concern about the U.S. economy and a possible recession, concern about economic and political turmoil in other countries has caused investors to flock to the more stable U.S. dollar. This is especially true for the euro, where Europe’s exposure to the war in Ukraine and the impending energy crisis have weakened the bloc’s currency.
More: Recession in 2023 predictions are growing: should investors worry?
Why could a strong USD be bad for business?
There are a couple of reasons why a strong dollar can actually be a negative for American companies.
First, a stronger dollar means that U.S. manufactured goods are more expensive overseas. This means buyers in other countries will need more of their currency to buy products. This increases the price they pay for U.S.-made goods. This can mean foreign buyers seek goods made elsewhere and makes U.S. companies less competitive on the local market.
Second, the value of overseas revenue is deflated once businesses convert it into dollars. For companies that generate a lot of business in other markets this can mean they’re earning less than they were before, without even taking inflation into account. This is especially true for the tech sector, which brings in a lot of revenue from overseas markets.
This double whammy could mean a decline in the earnings of U.S. companies — which is ultimately bad news for the stock market.
Which companies could be hit the hardest?
Companies have been warning about the stronger dollar for months. Many of the companies that have come forward this earnings season are tech companies.
Netflix has blamed the U.S. dollar for losing $339 million in expected overseas income, while Johnson & Johnson lowered its revenue forecast for the year. Microsoft's earnings fell short due to the strong dollar, while Salesforce expects to take a $600 million hit in revenue. IBM, Apple, Spotify and Google have also cited the strong dollar for lackluster earnings.
In fact, multinational firms were hit with a $24 billion impact in earnings from currency volatility, according to currency firm Kyriba.
“A strong U.S. dollar may reduce inflationary pressures over time, but currently [forex] volatility is wreaking havoc on the overseas revenues of multinationals,” Wolfgang Koester, chief evangelist of Kyriba, said in a press release.
The bottom line: What does a strong dollar mean for investors?
Is the strong dollar good or bad? It depends on who you ask.
For many tech companies and other sectors that rely on international clients, the strong dollar is eating into their earnings. And a disappointing earnings season often means a decline in the stock market. That’s potentially bad news for investors who have a position in stocks.
However, foreign companies with U.S. business benefit from the stronger dollar, as it inflates the value of their U.S.-generated revenue. This could be good news for investors who have holdings in foreign-based companies, like ADRs. Not to mention that a stronger dollar could also attract more foreign investors in the U.S. market.
The stronger dollar could also put downward pressure on rising inflation, helping to somewhat stabilize the economy. In turn, that could help companies who rely on imports, as it would make them cheaper.
Finally, because commodities like oil are priced in dollars, it could also help lower the price drivers are paying at the pump. And with more Americans going on vacation in Europe this summer, their spending abroad could ultimately help ease price pressure in the U.S.