By Tim Courtney, Chief Investment Officer
The dollar has been consistently grinding higher for most of 2022 and is up 11% year-to-date.1 One reason it has performed so well against other currencies is the actions of the respective central banks. Although the Federal Reserve (Fed) didn’t move as quickly as it should have to curb inflation, it has been relatively aggressive with four rate hikes since March.2
Most other central banks have remained passive by comparison. The European Central Bank just announced its first rate hike in 11 years,3 on the heels of the dollar reaching parity with the euro for the first time in two decades.4 Meanwhile, the Bank of Japan is stubbornly keeping rates near zero5 despite the yen being down about 17% against the dollar year-to-date (YTD).6 The result is a surging dollar and its effects, aside from making foreign travel very attractive for U.S. citizens, can be seen in three key areas:
- Commodities and real assets: Commodities have weakened appreciably during the dollar’s most recent surge. When the dollar is weak, many investors look to hold real assets in an attempt to hedge dollar decline. The opposite is happening now; the market is looking to the strong dollar as a source of stability, and the prices of commodities, while still positive for the year, have fallen since mid-June.
- International returns/earnings: The returns that we see from investments held overseas are reported in U.S. dollar terms. Across the globe, broad foreign markets have performed better YTD than broad U.S. markets unadjusted for currency. However, factoring in currency, the U.S. markets are now slightly outperforming most foreign markets.7 Additionally, as U.S. companies translate their foreign earnings back to U.S dollars, they are finding that earnings, while relatively good overall, are slipping due to currency translation.
- Inflation: As bad as inflation has been, the strength of the dollar is providing some relief. Many of the goods that we buy and use are imported, and these prices would be even higher had the dollar not strengthened. The last time we saw inflation at these levels, the late 1970s and early 1980s, the dollar was falling and making inflation worse. The dollar began rising in 1981 at about the same time the Fed began raising rates to stave off that bout of inflation.
What has happened so far this year is an important reminder that as much as cryptocurrency can dominate financial news, the dollar remains the global standard for a store of value. A dollar itself doesn’t produce cash flows and obviously can’t be used, and as such, it’s only worth what someone else is willing to exchange for it. Thankfully, the world continues to demand U.S. dollars.
If you have questions about how the strength of the dollar impacts your assets, please contact your Exencial advisor.
- MarketWatch (7/28/22) — U.S. Dollar Index (DXY)
- CNBC (7/27/22) — Fed hikes interest rates by 0.75 percentage point for second consecutive time to fight inflation
- CNBC (7/21/22) — European Central Bank surprises markets with larger-than-expected rate hike, its first in 11 years
- The New York Times (7/13/22) — Euro falls to equal the U.S. dollar for the first time in 20 years
- CNBC (6/17/22) — Bank of Japan maintains ultra-low rates, warns it is closely watching yen moves
- The Wall Street Journal (7/28/22) — Japanese yen
- MSCI.com (8/3/22) – MSCI Indexes, Performance, End of Day Data Regional
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