Is the US Dollar going to become stronger still?

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Even for mighty Microsoft, $595 million is a lot of money. That’s how much the software giant’s sales were reduced in the most recent quarter by the ever-stronger U.S. dollar. Indeed, a broad range of U.S. large-cap companies have been trimming forecasts due to a drop in repatriated profits that results from dollar strength. 

In Africa and the Middle East, nations are drawing down dollar reserves in a bid to defend against an even deeper rout in their currencies. Fotopoly/Dreamstime

Yet near-term sales and profit trends are just the tip of the spear when it comes to the impact of a strengthening dollar. Of far greater importance is the potentially damaging global economic effects that currency strains are triggering. Financial advisors who have been complacent about these risks need to sit up and take notice now that it’s clear the Federal Reserve will continue to hike interest rates, a path of action likely to boost the dollar even more.

Past contagions. Many Wall Street strategists haven’t been in business long enough to remember when a currency crisis caused stock markets to plunge in 1987, leading Treasury Secretary James Baker to pursue emergency trade and currency meetings with his counterparts in Europe. A decade later, a run on the Thai baht led to yet another global market rout.

Once again, dislocations in currency markets threaten to wreak havoc. The U.S. dollar index has surged from 92 to 109 over the past 12 months. The euro, yen, and other major currencies now stand at a more than 20-year low against the dollar. The Chinese yuan looks in particular peril lately. Since Federal Reserve Chairman Jerome Powell assumed a more hawkish stance at Jackson Hole last Friday, the Chinese currency has fallen to a two-year low against the dollar.

Mike Green, a portfolio manager with Simplify Asset Management doesn’t mince words when it comes to fresh currency risk. Continuing dollar strength “has the potential to really destabilize global markets.” He says it’s too early to worry about a “full-blown crisis,” but he adds that “a lot of people in my world, the macro world, are talking about the dollar and its impacts.”

Nations like Germany are clearly headed for a crisis, recently announcing a monthly trade deficit for the first time in more than 30 years, thanks to surging import prices, which have been exacerbated by the weak euro. Trade deficits do not necessarily signal crisis conditions, but this coming winter, Germany will likely make economy-sapping power cuts as it weans itself off Russian energy supplies, adding to the currency woes. 

Perhaps nobody has more to lose from a strong dollar than emerging markets in Asia, the Middle East, and Africa. (Latin American emerging markets, by contrast, are heavy exporters of various commodities, and such exporters benefit from strengthening currency reserves and see their currency strengthen as well, though that can lead to what’s known as a Natural Resource Curse). 

In Africa and the Middle East, nations such as Nigeria, Ghana, Egypt, and Turkey are drawing down their dollar reserves in a bid to defend against an even deeper rout in their currencies. Trouble spots such as Sri Lanka and Pakistan are already under duress in Asia, and other nations in that region may follow suit.

Withering reserves. These nations are burning through foreign currency reserves to pay for higher-priced imports. A broad range of commodities are priced in dollars, and the cost of energy, food, and raw materials is blunting economic activity across the globe. The International Monetary Fund (IMF) recently noted that “cumulative outflows from emerging markets (thus far in 2022) have been very large, about $50 billion.”

Source: El Economista