The US dollar has been on a remarkable upward trajectory over the past decade, showcasing its strength against major currencies worldwide.

This phenomenon has significant implications for US investors, whether they invest in international markets or domestic companies with global operations.

According to data from the Federal Reserve, the US Dollar Index (DXY), which measures the dollar's value against a basket of major currencies, has risen by approximately 30% since early 2014.

This surge in the dollar's value can be attributed to several factors, including the relatively strong economic performance of the US compared to other major economies, higher interest rates set by the Federal Reserve, and the dollar's status as a safe-haven currency during times of global economic uncertainty.

For US investors with international holdings, a stronger dollar can be a double-edged sword. 

• On one hand, it reduces the value of their foreign investments when converted back into dollars, potentially diminishing returns.

• However, it also makes foreign goods and services more affordable for US consumers, benefiting companies that import from overseas.

• On the flip side, US-domiciled companies that export goods and services abroad face challenges due to the stronger dollar. Their products become more expensive for foreign buyers, potentially impacting their competitiveness and earnings.

Some Real-World Examples

Challenges for US Exporters:

Apple Inc.: Despite its global brand recognition, Apple's earnings have been impacted by the strong dollar.

In the first quarter of 2023, Apple reported a 5% year-over-year decline in revenue, with CEO Tim Cook citing the strong dollar as a significant headwind.

According to the company's financial statements, Apple's international sales, which account for nearly 60% of its total revenue, were negatively impacted by approximately $5 billion due to unfavorable exchange rates.

Opportunities for US Importers:

Walmart Inc.: As a major retailer that sources a significant portion of its products from overseas, Walmart has benefited from the strong dollar.

In its 2022 fiscal year, the company reported a 2.4% increase in gross profit margins, attributing part of this improvement to the favorable currency exchange rates that lowered the cost of its imported goods.

Impact on International Investments:

Consider an investor who purchased shares of the iShares MSCI EAFE ETF (EFA), which tracks international developed markets, in early 2014 when the US Dollar Index stood at around 80.

Despite the underlying international stocks potentially appreciating in value, the stronger dollar has eroded the returns for US investors. An investment of $10,000 in EFA in January 2014 would be worth around $11,500 today, representing a modest 15% gain over the past nine years.

However, if the dollar had remained at its 2014 levels, the same investment would be worth approximately $13,500, a 35% gain.

These examples demonstrate how the strong dollar can pose challenges for US exporters like Apple, whose products become more expensive for international buyers, while benefiting importers like Walmart, who can source goods more cheaply.

Additionally, the example of the EFA ETF highlights how currency fluctuations can impact the returns of US investors in international markets, underscoring the importance of diversification and hedging strategies.

Outlook for the US Dollar

The outlook for the US dollar going forward is likely to be influenced by potential interest rate cuts by the Federal Reserve in the coming months, as well as contrasting monetary policy stances from other major central banks like the European Central Bank (ECB) and the Bank of Japan (BoJ).

• If the Federal Reserve proceeds with interest rate cuts in the next few months, as widely anticipated by markets, it could potentially weaken the US dollar. Lower interest rates typically make the dollar less attractive to foreign investors, as they can earn higher yields elsewhere, reducing demand for the currency.

• On the other hand, if the ECB follows through with its expected rate cuts, it could put downward pressure on the euro against the dollar. This divergence in monetary policy between the US and Europe could offset some of the potential dollar weakness resulting from Fed rate cuts.

• However, the situation with the Bank of Japan is different. If the BoJ raises interest rates in the next year, as expected, it could strengthen the Japanese yen against the US dollar. A stronger yen would make Japanese exports more expensive and potentially hurt the competitiveness of Japanese companies in global markets.

Wall Street Forecasts and Projections

While forecasting currency movements is inherently challenging, several financial institutions and research firms have published their projections for the US dollar in the near future.

Goldman Sachs: The investment bank expects the US dollar to weaken against major currencies in 2024, with the DXY (US Dollar Index) forecasted to decline by around 5% by the end of the year.

JPMorgan: The bank's strategists predict that the dollar will remain broadly stable in 2024 but may start to weaken in 2025 as the Federal Reserve potentially pauses its rate hike cycle.

ING: The Dutch bank's analysts anticipate the dollar to continue its downward trajectory in 2024 and 2025, citing the narrowing interest rate differential with other major economies as a key driver.

Overall, while projections vary, many analysts anticipate a gradual weakening of the US dollar in 2024 and 2025, primarily driven by narrowing interest rate differentials and potential shifts in global economic dynamics.

However, the dollar's status as a safe-haven currency and its role in international trade could continue to support its value, particularly in times of uncertainty.

Implications:

A weaker US dollar would immediately make international investments more attractive to US domiciled Investors.

Instead of suffering currency losses like those of the last ten years, US investors would receive the local currency return on the investment plus an expected gain from currency.

A weaker US dollar would also have company-specific effects:

• For export-dominant companies, a weaker US dollar would make their goods and services from a local currency basis potentially enhancing the competitiveness of US-sourced products.

• On the other hand, a weaker US dollar would make importing into the US more expensive. This would potentially boost inflationary pressures domestically and hurt importers such as Walmart.

The Big Picture:

• Equities keep outperforming bonds over longer holding periods, but last week we saw all key asset classes except for Commodities take a hit.

• The big losers last week were REIT investors as hopes for an interest rate cut were dimmed by higher-than-expected inflation numbers.

• The investment environment remains risk-on but less so than over the last month. Our proprietary Risk Aversion Index was up for the week but remains in the Exhuberant Zone.

Economy:

• The employment picture in the US remains mixed with the unemployment rate in the US moving up to 3.9%

• The US economy remains, however, on solid footing. The real worry remains inflation, not growth even though retail sales failed to match expectations.

• Both the Consumer Price Inflation and its counterpart measuring Producer Prices exceeded expectations. Inflation is running slightly above 3% per year, a long way from the 2% target of the Federal Reserve.

Equities:

• US Large Cap equities retreated last week with the S&P 500 down 0.1%., but the biggest losers were US Small Equities (down 2%).

• Growth and Value performed in line with each other. Low Volatility and dividend-oriented strategies had small gains last week

• Energy stocks benefitted from rising oil prices driven to a large scale by supply disruptions in the Middle East and Russia.

• On the international front, the Japanese equity market took a tumble as monetary policy in Japan is increasingly pointing to rate hikes. Year-to-date the MSCI Japan index is up 7.6% in US dollar terms.

Bonds:

• The Federal Reserve/Wall Street standoff continues. Wall Street strategists are betting that the first rate cut comes in June, but the Fed does not seem to be in a hurry.

• I am inclined to think that rate cuts will have to wait longer. The signal will be a weaker economy which for now does not appear on my short-term horizon.

• The bond market seems to be handling the standoff well. Corporate spreads are declining indicating fewer credit concerns.

• The 10-year Treasury yield rose 21 basis points last week hammering holders of long bonds.

• As Fed policy returns to a more accommodative stance the expectation should be for the diversification benefits of US bonds to increase as an effective offset to equity market performance especially during periods of market stress.

Alternatives:

• Cryptocurrencies have been on a roll in the last few weeks. The issuance of several Bitcoin ETFs seems to have fueled the rally. The next ETF expected to be approved this summer is Ethereum.

• On the negative side, there seems to be no real floor for natural gas prices. Spot prices are down 34% thus far in 2024 after being down 43% last year. A mild winter is one factor with excess oil production in the US being another (natural gas is a byproduct of oil production accounting currently for about 20% of the market).

• Gas prices have also been on an uptrend recently and we’re not yet experiencing the usual bump in consumption normally seen in the summer months in the US. Year-to-date spot gasoline prices are up 29%. Part of this is due to refinery capacity shortages as well as rising crude prices (WTI is up 13% in 2024)

• Energy accounts for almost 7% of the weight in the US Consumer Price Index. Further spikes in energy costs are likely to pressure future inflation trends.

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