The U.S. Dollar has been on a tear. There are a few reasons why demand for the “greenback” has been so hot, but the biggest reason is when global markets go crazy, investors look for a safe haven. The global uncertainty in Ukraine has made the U.S. Dollar attractive for global investors. Additionally, rates in Europe and Asia are lower. Because of America’s strength, the Fed raised rates “earlier” than many other central banks (albeit still too late). Bankers in Europe just started to increase interest rates while the Fed’s been at it for months. This led to relative attractiveness and a flight towards higher yielding, safer bonds.
What’s the Dixie?
The main way we track the strength of the U.S. Dollar compared to other currencies is via the U.S. Dollar Index (DXY) or “Dixie”. It was created by the Federal Reserve back in the ‘70s as a way to measure the moves in our currency after the collapse of the Bretton Woods system. Thanks to the European unification, the Euro makes up a little over half of the index. The Japanese Yen, UK’s Pound Sterling, Canadian Dollar, Swedish Krona, and Swiss Franc make up the rest.
Implications
The biggest drawback of a strong dollar is for American companies that do a lot of international business, like technology and industrial companies. A strong U.S. dollar makes U.S. goods more expensive for foreign buyers. Looking specifically at the Euro, you’ll notice that it has fallen from about $1.22 per €1 to around $1.03 per €1. Practically speaking, if you sold a subscription to Microsoft’s Office365 for €100 a year ago, that would have translated to $122 in inflows. But now €100 only gets you $103! A huge difference. Another example is Ford (F), a large American company, whose overseas sales account for about a third of its overall business. When currency conversion is applied (from the Euro to the Dollar), they may take a loss because of the difference. Microsoft (MSFT), like many tech companies, generates almost 50% of its business overseas and blames the strong Dollar for some of their weakness. Of course, it would be foolish to avoid tech as a sector just because of today’s temporary strong Dollar.
From the fixed income point of view, many people have rushed into emerging market bonds to earn a little extra yield or income. You might get a little extra income, but it’s not enough to compensate you for the change in the currency conversion back to U.S. Dollars. Using the previous example, if you received €100 worth of interest, that means you only got $103 in your back versus $122 a year ago. The little extra income isn’t enough to compensate for the 20% currency loss. Apriem continues to avoid this area for clients.
The strong U.S. Dollar has been a headwind for many global companies, but we think it is a modest headwind at worst. The strength will likely continue given the global uncertainty, specifically the tensions in Ukraine and Taiwan, as well as the economic weakness in Japan and China. Rising interest rates in Europe and U.K. could slow the Dollar’s rise but as long as the Fed continues to raise rates, expect the U.S. Dollar to remain strong.
Benjamin Lau, CFA
Chief Investment Officer