Excerpt from Silvercrest’s Q2 2017 Market Commentary Call
Which is better for the U.S., a strong or a weak dollar?
A dollar that is expensive, compared to other currencies, gives American consumers greater purchasing power, but it also makes U.S.-made goods more costly for others to buy, potentially widening the trade deficit. It also cuts into the pricing power of U.S. companies at home, as well as the value of their earnings abroad, in dollar terms. A cheaper dollar does the opposite, giving a potential boost to U.S. growth and earnings, at the expense of reducing the buying power of American consumers.
What’s been driving the U.S. dollar lately?
The value of the dollar is driven by demand from people around the world who want dollars to buy U.S. goods or U.S. assets. The U.S. economic recovery has been stronger than in Europe or Japan, and the Federal Reserve has been starting to raise interest rates, even as those countries continue to ease. Those higher rates attract funds into the U.S., which has boosted the dollar. We saw that through 2015, in anticipation of Fed tightening. The stronger dollar was also creating significant headwinds to U.S. growth at that time, widening the trade deficit and cutting into U.S. corporate earnings.
When the Fed was more patient in raising rates than many people expected, the dollar stabilized through most of 2016, and those headwinds to growth were reduced.
What does this mean for the U.S. economy?
Those movements in the dollar are one reason we continue to see positive, if uninspiring, growth rates in the U.S., with neither a break-down or a break-out in either direction. What we’re seeing is the U.S. dollar acting as a regulator on the U.S. economy. If growth gets too far ahead of the global growth rate, the dollar rises and that growth gets reined in. If growth falters, the dollar weakens and helps support it.
What moves in the dollar have we seen more recently?
Right after the election, the dollar surged to a 14-year high, on a broad trade-weighted basis. That’s because many people expected the Trump Administration to enact policies—like tax cuts, more defense and infrastructure spending, etc.—that would boost demand, further increasing pressure on the Fed to tighten more aggressively. In the new year, as doubts have grown whether those policies will happen as quickly or smoothly as many thought, the dollar has come back down.
What we’re seeing is the U.S. dollar acting as a regulator on the U.S. economy.
When the dollar surged, the headwinds to growth from a strong dollar returned. A wider trade deficit shaved −1.8 points off GDP in Q4. Since the dollar declined, those headwinds have receded—for now. The trade deficit stabilized in Q1, contributing +0.1 points to GDP growth. But this isn’t about the president talking the dollar up or down. If nations could do that, in any sustainable way, we’d live in a very different world. It’s policy, not posturing, that’s ultimately the deciding factor.
What does all this mean for investors?
The first thing is what it means for U.S. growth. It’s not easy for President Trump to boost U.S. growth through stimulus, if that causes a stronger dollar that reins in growth. But a weaker dollar, in the face of disappointments, also helps put a supportive floor under growth.
The second thing is how exchange rate movements affect returns on non-U.S. assets. In 2016, London’s FTSE 100 rose +14.4%, but because the pound fell −16.6% against the dollar, the index’s value actually fell −4.6% in dollar terms. Both gains and losses to Japan’s Nikkei were also largely cancelled out by fluctuations in the yen against the dollar. It is important to keep currency movements in mind when thinking about potential returns in overseas markets.
This communication contains the personal opinions, as of the date set forth herein, about the securities, investments and/or economic subjects discussed by Mr. Chovanec. No part of Mr. Chovanec’s compensation was, is or will be related to any specific views contained in these materials. This communication is intended for information purposes only and does not recommend or solicit the purchase or sale of specific securities or investment services. Readers should not infer or assume that any securities, sectors or markets described were or will be profitable or are appropriate to meet the objectives, situation or needs of a particular individual or family, as the implementation of any financial strategy should only be made after consultation with your attorney, tax advisor and investment advisor. All material presented is compiled from sources believed to be reliable, but accuracy or completeness cannot be guaranteed.