The strongest dollar in two years is showing few signs of softening, piling yet more pain on U.S. exporters already smarting from the escalating trade war with China.
The Dollar Index, a measure of the dollar against some of its most traded developed market peers, closed at 98.2030 on April 25, the highest level since May 2017, as global economic weakness and relatively high U.S. interest rates boosted the relative attractiveness of the currency. It has strengthened 10.2% since hitting a more than three-year low Jan. 9, and was trading at 98.0090 at 6 a.m. ET on May 29.
U.S. economic outperformance has allowed the Federal Reserve to raise interest rates while central banks in other developed economies have kept them near zero or negative, increasing the relative attractiveness of U.S. assets. At the same time, uncertainty around the future direction of trade talks between the Trump administration and China, as well as issues such as Brexit weighing on rival economies, have bolstered the dollar as investors sought a safe haven to park their cash.
"The dicier things are, the stronger the U.S. dollar gets," Mark Hopkins, director and senior economist for Moody's Analytics, said in an interview. "I think that the current strength is going to be sustained before it comes back down."
While a strong dollar can provide some relief for consumers facing higher prices thanks to tariffs on Chinese goods, it is bad news for U.S. companies that rely on selling goods abroad as they usually have to either accept reduced margins or lower sales, depending on whether they cut prices to counter the currency's strength.
Several consumer companies, including The Procter & Gamble Co., Kimberly-Clark Corp. and Colgate-Palmolive Co., expressed concern about the strengthening U.S. dollar in their latest quarterly earnings calls. The three companies have collectively made half their net sales outside of the U.S. in recent years.
P&G said on April 23 that the stronger dollar had dented sales of its grooming products, leading to a 3.3% drop in its share price on the day. Operating margins declined 60 basis points to 19.9% at P&G in the quarter ended March 31, as currency fluctuations added to higher commodity and transportation costs.
Agricultural exports have also been hit by the stronger U.S. currency. Lobby Group Potatoes USA has identified the dollar as a drag on overseas sales a number of times this year.
The cost of commodities, mainly priced in dollars, tend to move inversely to the U.S. currency as oil, copper and so on become more expensive outside the U.S. as the dollar strengthens and vice versa.
However, the negative correlation between commodities and the dollar varies over time and from commodity to commodity. Over the past two decades, changes in the value of the dollar only explain around 10% of moves in WTI crude and 6% in Brent, according to energy analyst Elliott Gue.
President Donald Trump has voiced his concern about the potentially negative effects of the dollar on the U.S. economy.
"I want a strong dollar, but I want a dollar that's going to be great for our country," Trump told the Conservative Political Action Conference in March. "Not a dollar that's so strong that it is prohibitive for us to be dealing with other nations and taking their business."
Many of the factors behind the dollar's strength do not look like dissipating any time soon.
China has allowed the yuan to weaken in response to U.S. tariffs on Chinese goods; a tepid European economy has seen capital outflows from the region; uncertainty around Brexit has weakened the pound, which fell against the euro for a record 14 straight sessions through May 23. Central bank rate cuts by New Zealand, the Philippines and Malaysia in May have contributed to the depreciation of their currencies against the dollar, while the Aussie dollar has also depreciated against the American dollar due to expectations of another rate cut.
With a looming batch of tariffs on $300 billion of Chinese products, further yuan devaluation could be on the way, although many strategists believe the Chinese government will step in to prevent any decline beyond 7 per dollar. It traded around 6.9095 in New York today.
Rhetoric from Matteo Salvini, Italy's deputy prime minister, that the country should be ready to break the European Union's deficit ceiling of 3% of GDP and push debt to 140% of GDP to lower the unemployment rate, could place additional pressure on the euro, the Forex.com analyst Fawad Razaqzada wrote in a note.
Downside risks to the dollar include a more dovish Federal Reserve, a stronger global economy or an end to the U.S. trade war with China, although the latter is unlikely in the eyes of many analysts.
If anything, the trade war seems to be intensifying after the Trump administration banned U.S. companies from doing business with Chinese technology giant Huawei Technologies Co. Ltd.
That could mean more strengthening for the dollar going forward, said Rajeev Dhawan, the director of the economic forecasting center at the Robinson College of Business at Georgia State University.
"When the world economy is weak, where do you want to park your extra cash? That tends to be the U.S.," Dhawan said in an interview.