In the eyes of many, America’s response to the growing threats from Islamic terrorists in the Middle East and the situation in eastern Ukraine has diminished our country’s reputation as the leader of the free world. According to the latest polls, a growing number of Americans believe that Obama is ill-equipped to handle these multiple international crises.
Yet there is one arena in which the United States’ power and influence in the world is increasing: the global economy. Judged by the popularity of its currency, the U.S. is the place to be. The greenback is coming off its longest winning streak in 17 years: nine straight weeks of gains, according to the ICE U.S. Dollar Index. It has reached its highest level against the Japanese yen since October 2008 and the strongest against the euro in 14 months.
The reason most commonly cited for the strength of the dollar is the highly anticipated onset of higher interest rates in the U.S. as the Fed gradually begins to tighten monetary policy sometime next year. At the same time, European and Japanese central banks are moving in the opposite direction, designing policies to further stimulate their moribund economies. The result is a widening gap between U.S. and international interest rates and higher demand for U.S. assets, causing the dollar to appreciate.
The ramifications of a stronger dollar are numerous and wide-reaching. Combined with the boom in U.S. energy exploration, the strong dollar has lowered the price of energy for U.S. consumers and businesses. The resultant decline in gasoline prices has a direct and positive effect on consumer purchasing power, the key driver behind U.S. economic growth. Since commodities are priced in dollars, the rise in the greenback has neutralized the benefit of lower oil prices in other countries, extending the cost advantage between the U.S. and other developed economies.
A strong U.S. dollar also helps keep inflation low because it keeps the cost of imports down and forces domestic manufacturers to maintain pricing discipline to remain competitive. Low inflation could allow Fed Chair Yellen to keep rates lower for longer in order to stimulate more growth – another positive for U.S. stock prices.
However, a strong dollar is not a panacea for all that ails our economy. Although imports will be cheaper (helping those countries that depend on exports to the U.S. for a large part of their growth), the strong dollar raises the cost of our exports, thus widening our trade deficit. Multinational companies based in the U.S. will face downward pressure on their profits as they convert foreign earnings back to local currency. At the same time, emerging market companies that have benefitted from the Fed’s easy money policy by borrowing in dollars to fund their operations may find it increasingly difficult to repay their debts with revenues generated in their home currencies.
If the trend continues, we believe the implication for U.S. investors is clear: maintain a “home country” bias, but be diversified. With so many parts of the world engulfed in military conflict, the U.S. economy still looks like a pretty good bet.
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