Plenty of Support for Stronger Dollar
Trade data, low rates abroad, and diverging growth patterns support a stronger dollar, says Morningstar’s Bob Johnson.
Plenty of Support for Stronger Dollar
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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Is the stronger dollar justified and what impact is it going to have on the United States? I'm here with Bob Johnson--he is our director of economic analysis--to take a closer look at these questions.
Bob, thanks for joining me.
Bob Johnson: It's great to be here today.
Glaser: Let's start by putting the rise of the dollar in context. What's the best way to look at it and just how much is the dollar up over, say, the last year?
Johnson: The best way, I think, to look at it is on what I call a trade-weighted basis, which says, with our trading partners, we're up really strong versus this one, but it's not much of our trade. How do we weight these? So, it's by the amount of trade that we actually do with that country. And right now, we're between 17% and 18% on a trade-weighted basis, year over year, on the dollar. So, it's really had a pretty dramatic move. And certainly on whatever day you look it, we are probably pushing 20%--and we've only had that 20% move five times since 1970. So, over a 45-year period, we've very seldom seen this 20% move that we are seeing right now.
Glaser: This is a rare event, then. Is it justified or is it more speculative? Do you see real, fundamental reasons for the dollar to be this strong?
Johnson: I think the dollar should have been strong sooner, and I think there are some very real, fundamental reasons for why it's now come back up again. I think it's up for all the right reasons. With foreign currencies, things always tend to swing too far and tend to move all at once and catch up for things they've missed over the years. And certainly, we've been talking forever about the oil situation here in the U.S. and the rising production here and what that's done to our trade deficit--which has frankly usually hurt our GDP, because usually when the economy grows, we pull in a bunch oil. Well, this time, the oil is coming from the U.S. itself.
So, we just had a major improvement in the trade-deficit situation, and that's one of the absolute drivers of the strength of your currency, because obviously the more things you do internally and the more people want your stuff, the higher demand for dollars then causes the price of the dollar to go up. So certainly, that's been something that we haven't seen and finally we are.
Then, [one of] the other two things would be the relative interest rate. We've talked many times about Europe and the QE and what that's done. Italy, this morning, which was one of the riskier European economies, has a 10-year Treasury rate of 1.2%. We are kind of at the 2% level right now here in the U.S. So clearly, there is a huge spread, and that's causing investors to say, "Let me invest in the U.S., let me add it." Again, you first have to use dollars to go buy that stuff, and so it has clearly helped put the dollar up as well.
Certainly, the other thing that we're seeing in the data is the GDP momentum. Clearly, most countries in the world are slowing down a little bit, not doing as well as they were. Even last week, we saw China--which was growing, at one point, as high as 10% five years ago--growing more like 7.5%. And then last week, they came out and said that it was more like 7%. At the same time, the U.S. has gone from 2% to 2.25%. We've seen a couple of even better quarters, which really means that the U.S. is gaining momentum. And so, again, when you've got that strong internal demand and people want your stuff, that's when you tend to have a stronger currency. So really, the stronger dollar is supported by fundamentals. But in some cases, like against the euro, where it's $1.05 or $1.06 versus $1.40 a year ago, it's really dramatic. You have to ask how much further can it go?
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Glaser: So, if we do think that the dollar move is justified at least somewhat and it could be with us for a while, what impact is this going to have both on the positive and on the negative side?
Johnson: Well, the really positive news is probably psychological. The U.S. has kind of regained its real strength as a powerhouse leader. I think, for a while, there was some thought that the U.S. is deteriorating. With the rise of China, [people were thinking], "Let's use the Chinese currency or use the euro as a reserve currency instead of the [dollar]." And that has all kind of gone by the way side.
I just saw an interesting note that 60% of [the foreign reserves] held by other central banks are in U.S. dollar right now versus the U.S. being 25% of world GDP. So, it's a pretty interesting phenomenon that we have regained some of that strength. So, that's certainly been an important factor. And it has certainly kept inflation down in the U.S. As we import goods, which we import a lot of, they are now at lower prices. So, it's really aiding the fight against inflation here, and it's making the U.S. dollar go further. And it's great for foreign tourism. This is the time to go visit Europe or any place else. We've had a number of people at Morningstar go overseas, and they are all reporting back what tremendous buys they have. So, that's really a very interesting situation.
Glaser: But it isn't all good news, right?
Johnson: Absolutely. Certainly, [it's a problem for] anybody who has a foreign investment or a foreign mutual or a foreign stock. Even if that stock or currency has done well in that local market, it translates back to fewer U.S. dollars. It's a 20% headwind that you've got to face almost upfront for an investment that you got overseas. So, it's a pretty tough situation there, and certainly it's affected corporate earnings. When you adjust it for all the right things, overseas sales should be about 25% to 30% of corporate S&P 500 sales.
To have that come in 20% is a pretty big deal. You can hedge some of that away--and certainly not everybody is oblivious to it and they've made some adjustments--but over the long run, that's a pretty big move, and it has begun to affect corporate earnings. We've seen a number of earnings reports where people are saying, "Well, we would have done better"--be it Procter & Gamble (PG) or even Wal-Mart (WMT) [or a number of other companies with] some operations overseas who are reporting on this phenomenon. So clearly, corporate earnings are taking a little bit of a hit from this overseas phenomenon, and I think it's probably a little bit broader than people expected.
We went through this period in 2010-12 where S&P earnings did really well and the U.S. economy just did kind of so, so. Now, we're coming into a period where the U.S. economy is doing well, but S&P 500 earnings not so much because of this foreign factor in the numbers that people have to remember.
Glaser: Bob, thanks for your thoughts on the dollar today.
Johnson: Thank you.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
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