The U.S. Dollar Falls
The value of the U.S. dollar continues to fall against its major trading partners, due to a potent concoction of politics and surprising economic growth abroad.
U.S Dollar Index
Source: Bloomberg, as of 1/25/18 Past performance is not indicative of future results. Investments cannot be made in an index. The U.S. Dollar Index (USDX) indicates the general international value of the USD. The USDX does this by averaging the exchange rates between the USD and major world currencies. Click here for more information on the basket.
What Does That Mean?
The dollar, as measured by its value against a basket of currencies, has fallen more than 2.5% already this year, following a 7% decline in 2017. A broader trade-weighted basket of currencies measured by the Fed is less severe, but nevertheless, dollar weakness was particularly apparent this week.
U.S. politics deserve some credit. U.S. Treasury Secretary, Steve Mnuchin, asserted that a weaker dollar is good for the U.S., as it “relates to trade and opportunities”. This comment runs counter to nearly 25 years of U.S. Treasury strong dollar policy. Markets are speculating whether a policy shift is occurring, but Secretary of Commerce, Wilbur Ross, subsequently denied it.
The dollar’s weakness may be more correlated with strong global growth – particularly in Europe. The euro-area economic strength continues to exceed consensus forecasts, and European PMIs (surveys of manufacturers) released yesterday signal further progress ahead.
Figure 2: Dollar Weakness or Euro Strength?
EUR/USD Exchange Rate
Source: Bloomberg, as of 1/25/18. EUR/USD Spot Exchange Rate where the price of 1 euro is in U.S. dollars.
Why Does It Matter?
A weak dollar has implications for many investments and asset classes. We see three particularly important ones:
- A weak dollar is indirectly bad for bonds, as it leads to higher inflation (imported goods cost more) and thus a potentially more hawkish Federal Reserve.
- A weak dollar tends to boost globally-traded commodities, like crude oil and gold, as they become relatively more expensive in dollar terms. We expect higher prices to translate to better earnings in the energy and materials sectors.
- A weak dollar favors larger multi-national companies over smaller companies, as U.S. exports become relatively cheaper and more competitive in global markets, and overseas revenues are boosted in USD terms.
The dollar’s current weakness will certainly create winners and losers, and the impact on foreign investors’ appetite for U.S. equities and fixed income will be important to watch. Looking ahead, the dollar could strengthen from here; however, currencies are notoriously difficult to predict. As such, it may be futile to speculate on the direction of the trade. Investors may be well served by removing currency volatility from their investments with a 50% hedge.
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The ICE U.S. Dollar Index (USDX) is a leading benchmark for the international value of the U.S. dollar and the world’s most widely-recognized traded currency index. In a single transaction the USDX enables market participants to monitor moves in the value of the U.S. dollar relative to a basket of world currencies, as well as hedge their portfolios against the risk of a move in the dollar.
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