The Surging U.S. Dollar – Good For Some, Bad For Others by Gary D. Halbert
FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
March 17, 2015
IN THIS ISSUE:
- Wall Street Journal Survey of 63 Economic Forecasters
- Wholesale Prices & Consumer Spending Turn Lower
- Is the Surging U.S. Dollar Good or Bad For the Economy?
- How the Stronger Dollar Affects the US Economy
- Strong Dollar is Driven by Increasing Foreign Devaluations
- Soaring US Dollar Roils Stock Markets This Year
- Why I Would Reduce or Hedge Equity Exposure Now
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The U.S. Dollar has been surging against most other currencies over the last year. The question is, is the rising US dollar good for the economy and the investment markets, or not? No doubt, the rising dollar has been buffeting the US equity and bond markets this year and is increasingly cited as the main culprit. That is what we will delve into today.
Opinions differ whether a rising dollar is a net positive, or a net negative, for the US economy going forward. But as I will point out below, the strong U.S. dollar is a good thing, despite what others may say. However, the main reasons why the dollar is surging may surprise you.
The U.S. Dollar has risen about 33% from its low in April 2007. The euro is approaching a new low relative to the US dollar, reaching $1.05 last week, the lowest level since 2003. The euro could be at parity with the US dollar, or even less, very soon. But what does that mean for most Americans? We will answer that question today.
At the end of today’s letter, I will recommend that investors reduce exposure to equities or hedge long positions due to rising financial risks around the globe, which are reflected in the soaring U.S. Dollar . Be sure to read my analysis below.
Before we get into that discussion, let’s look at some recent economic reports and data. We start with the results of the latest Wall Street Journal survey of over 60 economic forecasters. Next, we look at the wholesale price index which has now declined for the last four months. And then we look at retail sales which have declined for the last three months, well below expectations. Let’s get started.
Wall Street Journal Survey of 63 Economic Forecasters
The WSJ just completed its March survey of over 60 economic forecasters, and the results were a bit disappointing. The forecasters, on average, expect the surging U.S. Dollar and global weakness elsewhere will keep the economy slightly below 3% growth for all of 2015.
The survey respondents forecast 1Q GDP growth of only 2.3%, not much better than the 2.2% in the 4Q of last year. They think the economy will grow by 3.0% in the 2Q but by only 2.9% for all of 2015, versus 2.4% in 2014. They expect the unemployment rate to fall from 5.5% currently to 5.1% by the end of this year.
On the question of when the first Fed rate hike will occur, over 80% believe it will come at either the June FOMC meeting or the September meeting – no surprise there. Almost two-thirds believe the Fed should raise the rate sooner rather than later. That seems very odd given that inflation is nowhere to be found.
Wholesale Prices Decline Fourth Straight Month
The Producer Price Index, which measures prices that businesses receive for their goods and services, declined by a seasonally adjusted 0.5% last month from January, the Labor Department reported last Friday. That marked the fourth straight monthly decline.
The so-called “core” PPI – excluding the volatile food and energy categories – fell 0.5% in February. Economists surveyed by The Wall Street Journal had expected prices would increase 0.3% and core prices would rise 0.1% last month. In January, the US saw its first year-over-year dip in overall consumer prices in more than five years, when the Labor Department’s Consumer Price Index fell 0.1% from a year earlier.
As I will discuss below, the stronger U.S. Dollar is suppressing inflation. Generally speaking, a rising dollar makes our imports cheaper and our exports more expensive for foreign buyers. Prices for imports outside of food and energy dipped 0.1% in February, and exports fell by 0.8% over the same period.
Consumer Spending/Retail Sales Turn Lower
To the surprise of just about everyone, consumer spending turned lower in December and January. Personal Consumption Expenditures (PCE) – the Fed’s favorite measure of how consumers are feeling – unexpectedly fell in January for the second consecutive month, and perhaps a third when we get the numbers for February.
Retail sales, for which we already have the February numbers, fell for the third month in a row. Retail sales fell 0.6% in February, 0.8% in January and 0.9% in December – all of which were considerably worse than expected.
After last year’s spectacular plunge in oil and gasoline prices, many analysts assumed that consumers would spend all of their gasoline savings on other things. Some overlooked the fact that even if you spend all your gas savings on other things, that still amounts to the same amount of spending.
Yet in reality, Americans on average did not spend all their gasoline savings on other things. Knowing there’s no guarantee that gas prices won’t go right back up again soon, many Americans have elected to sock away some of their gas savings, rather than spend it all. The US savings rate rose to 5.5% in January, the highest level since early 2013.
This explains why consumer spending fell in December and January (and likely February) and retail sales were down for the last three months, despite sharply lower gas prices.
Is the Surging U.S. Dollar Good or Bad For the Economy?
The US dollar has been trending higher since the bottom in early 2011. Since then, the dollar has gained apprx. 33% against a basket of major currencies. The ICE Dollar Index (DXY), a measure of the U.S. Dollar against six major currency rivals, is up over 9% this year alone to trade at its highest level since late 2003.
The fact that the US dollar is now higher than at any time in over a decade is attributed to various factors. Among them is the fact that the US economy is the strongest among developed nations, even though the recovery remains rather feeble. As the old saying goes, the US dollar just happens to be the best horse in the glue factory.
Another is the fact that rivals such as Japan and Europe are undertaking monetary policies (QE) that purposely undermine their currencies in misguided efforts to stimulate their economies. The euro, for example, fell to US$1.05 last week, down 12.4% this year alone and down 24% over the last 12 months.
If this trend continues, and it appears it will, the euro could fall below parity with the US dollar this year for the first time since 2002. Some analysts believe the euro is headed as low as 85 cents to the dollar before long. The Japanese yen is in even worse shape relative to the dollar.
Another factor buoying the dollar is the fact that the US Fed is widely expected to raise short-term interest rates this year. Higher interest rates will make the US dollar even more popular among international investors. Strong inflows to the U.S. Dollar have been increasing over the last year, pushing the dollar higher and higher. This trend should continue for at least several more months, possibly longer.
How the Stronger Dollar Affects the US Economy
Generally speaking, a higher U.S. Dollar makes foreign imports cheaper – we can buy more with the same amount of dollars, so that is good for the economy. This benefits US manufacturers that purchase foreign goods and services to make their end products. On the other hand, a stronger dollar makes our exports more expensive to foreign buyers, so this is a net drag on the economy.
The good news, if we can call it that, is that US exports account for only 13.5% of the economy, whereas imports account for apprx. 16%. According to the Census Bureau, US exports in 2013 (latest data available) were apprx. $2.2 trillion, versus imports of apprx. $2.8 trillion. So the net effect of a stronger dollar is slightly positive for the economy, despite what you may hear.
Yet a strong dollar can be both a blessing and a curse for the US economy. On the one hand, it means cheaper imports, which consumers love. Families will save money on clothes, cars, electronics, coffee, some really delicious cheese and all sorts of other imported staples.
On the other hand, a supercharged currency will make it harder for us to sell our own goods abroad. While exports aren’t quite as crucial to our economy as they are to Europe’s, for instance, they’re still important. As they fall, or grow more slowly, it could cut into job growth. Some manufacturers could even cut jobs.
There are other benefits from a stronger dollar that are less easy to quantify. For example, if you are planning a trip overseas, the stronger dollar is good news. If you have to convert your dollars to a foreign currency, you will be able to buy more of that currency. Conversely, the stronger dollar makes it more expensive for foreigners to visit the US.
Strong Dollar is Driven by Increasing Foreign Devaluations
The rising value of the U.S. Dollar is more the result of foreign nations devaluing their currencies than it is to robust economic growth at home. It would be nice if the surging US dollar was the result of a booming economy in America. While the US economy is growing, the recovery is still the weakest in the post-war era.
Yet as noted above, the US economy remains the least dirty shirt in the laundry basket. With foreign governments intent on devaluing their currencies, in misguided attempts to stimulate their economies, more and more foreign investors are choosing to park their money in U.S. Dollar-denominated assets. This further strengthens the dollar.
Given that the European Central Bank has just embarked on a $1 Trillion QE bond-buying effort, and Japan has doubled-down on its QE program, we can only wonder how long it will be before China follows suit. It could well be that China decouples its currency from the U.S. Dollar peg before long.
The point is, the strength of the dollar is not so much that the US economy is surging, but that foreign governments are choosing to devalue their currencies relative to the dollar in an attempt to stimulate their own economies.
So don’t be confused that the surging U.S. Dollar is a sign that the US economy is accelerating rapidly. It is merely a sign that the US dollar is the least worst currency in which to park your money. With the economies of Japan, Europe and China on the ropes, this trend could continue for some time to come.
Soaring U.S. Dollar Roils Stock Markets This Year
After rising to new all-time highs earlier this year, US stock markets have turned jittery in recent weeks. More and more analysts are citing the rapid rise in the U.S. Dollar as the culprit. As discussed above, the rising U.S. Dollar can cut into corporate profits, especially among multinational companies that make a lot of their profits overseas – assuming they bring those profits home, which many don’t.
It’s probably not the dollar’s unrelenting march higher that is unsettling US stock investors, but it might be the speed of the rally. On a trade-weighted basis, the dollar remains far from its highs in the mid-1980s and early 2000s, but the pace of the rise over the past half-year is the second fastest in the last 40 years.
As noted above, the dollar is up 9% just since the first of the year. The long-term correlation between the direction of the dollar and the S&P 500 is near zero. But there have been periods when the dollar and stocks marched either in lock step or in opposite directions for significant periods.
In the end, it all seems to come down to context. If the dollar rises because investors are confident about the future of the economy, then stocks can rise, too, as was the case in the late 1990s. But if the dollar is rising because investors are frightened and scrambling for safety, then it is no surprise that stocks and other assets perceived as risky tend to suffer.
Right now, it may be a case of the latter, with the speed of the dollar’s rise serving as the source of that economic anxiety. Stock investors shrugged off a rising dollar in 2014, but so far in 2015, the S&P 500 fell in 19 out of the 27 trading days when the dollar had risen, through last week. Investors now seem to be realizing that the global flight to the US dollar is not necessarily a good thing. I agree.
Why I Would Reduce or Hedge Equity Exposure Now
Hopefully today’s discussion about the strong U.S. Dollar has been helpful. However, it does raise some red flags, at least for me. Desperate actions by players ranging from the Swiss National Bank (which instituted negative interest rates) to the European Central Bank and the Bank of Japan are giving investors anxiety pangs. They fret over whether the measures will succeed in boosting those economies or will result in unintended negative consequences.
Specifically, U.S. Dollar strength reflects rising international systemic risk rather than cyclical normalization in global economic conditions. The rapid rise in the dollar of late may be a warning of developing global disinflation/deflation, demand weakness and financial default risk. The surging dollar hurts foreign borrowers whose loans are denominated in greenbacks.
I think we can all agree that the desperate actions taking place in Japan will not end well. It remains to be seen if QE will work in Europe in the near-term, but it is certainly not a long-term solution. Russia is bankrupt and with the glut of oil on the world market, it is a looming financial disaster.
China may not be far behind and may be the next major country to devalue its currency significantly. If so, that could amount to a race to the bottom for Japan, Europe, China and Russia in the months ahead, with more currency devaluations to come.
Since these players are our major trading partners, this will not be good for the US economy. I fear that this will weigh on the US equity markets this year. For that reason and others, I would look to reduce equity exposure, hedge long positions or consider some of the actively managed strategies that I recommend. Global financial risks are accelerating.
Very best regards,
Gary D. Halbert