The Mighty Dollar

One of our major concerns that’s developing now is the strength in the US Dollar. With the market pricing in a “higher for longer” scenario in rates, the US Dollar is correcting and may continue to remain strong for the remainder of the year with rate cuts being delayed. Suffice to say, that only a Fed rate cut would really “break” the the Mighty Dollar at this point.

Factors Driving the Strength in the US Dollar

The strength of the US dollar is driven largely when there is higher demand for the currency. The factors that seem to be influencing the dollar at this stage are:

• Higher Commodity Prices: Unpredictable weather patterns brought on by El Nino have been creating shortages in commodities, pushing up prices. Since most of the world’s commodities are priced in US Dollars, it creates more demand for the USD. El Nino weather patters are expected to last into Q3, 2024.
• Higher US Inflation and Rates: The Fed’s interest rate policies are a primary driver of the dollar's strength. Higher interest rates offer higher returns on investments in US assets, making the dollar more attractive to foreign investors.
• Risk Aversion and Safe Haven: The US Dollar is still considered a safe haven and with geopolitical tensions not subsiding, more people are either going to cash, or buying gold & US bonds which again creates demand for the dollar. Another tailwind could be the deceleration of US GDP growth that would also lead to some risk aversion.
• US Stock Markets & Assets: The US stock market has been bullish since late 2023 and this attracts more foreign investment into the United States which can strengthen the Dollar. The demand for other assets - corporate bonds, real estate - also create demand for the US Dollar.
• US Elections & Trade Policies: Most FX investors believe that if Trump were to win, the US Dollar might initially strengthen because of the possibility of increased US tariffs and a renewed global trade war. Over the long term, the effect of the election on the US Dollar would depend on the combination of trade, budget, energy, immigration, and foreign policies. Long USD is a hedge the traders are playing for the elections.

US Earnings

US multinational companies that earn a substantial amount of their revenue in foreign currencies may see a negative impact on profits when those earnings are converted back to dollars. This could affect their stock prices and overall financial performance. According to FactSet, almost 40% of earnings of S&P 500 companies come from overseas.

Emerging Markets

A stronger US Dollar means weaker currencies in other markets. This weighs more heavily on Emerging Markets where maintaining the stability of their currencies is already a challenge.

Most of the world’s commodities are priced in US Dollars, which means countries now either have to pay more for their commodity imports such as oil, or buy less of the said commodity creating a shortage. Either way, the result is higher prices in the country. This leads to inflation and we’ve been seeing this play out in some of the Asian countries, causing Central Banks to pause rate cuts. One such example is the Philippines.

A weaker currency also leads to challenges in paying back external debt which is priced in USD. Countries and businesses that hold debt denominated in USD will find it more expensive to service their debt (paying interest and principal), as the value of the dollar increases relative to their local currency. This can lead to financial strain and a slowdown in GDP growth.

Many of the Emerging Markets have managed to create reserves which will lessen the blow. As we see it, these factors weighing on the dollar may largely start to subside in Q3 reversing the strength. These reserves may help balance some of the currency depreciation.

While inflation remains unpredictable, if the Fed decides not to cut too soon, we may see higher rates start to work against inflation once again. Geopolitical risks, oil prices, the slowdown in US growth, and the US elections, however, continue to remain a concern, quite possibly until the end of 2024.

We remain cautious and vigilant on global equities, and currencies due to a stronger dollar. It’s only in markets that have their own growth tailwinds, such as India and Japan, where we may not see the USD weigh on equities.

Articles this Week from MacroVisor

Understanding the Cybersecurity Industry - https://www.macrovisor.com/p/understanding-cybersecurity-industry-investment-business

China's Property Measures: A Step in the Right Direction, but Are They Enough? - https://www.macrovisor.com/p/china-s-property-measures-a-step-in-the-right-direction-but-are-they-enough

Reach out to us for help with your investment strategy or email us at [email protected]

None of the above is investment advice. Full Disclaimer: https://www.macrovisor.com/c/disclaimer