The Euro famously fell below parity with the dollar on July 13, when one Euro traded for $0.998. This is only the 2nd time in the Euro’s 23 year history that this occurred, and it marked the first time in almost 20 years to the day (July 15, 2022) that one Euro was worth less than a dollar.
A strong U.S. dollar, with a simultaneously weak Euro and GBP (the Pound came dangerously close to parity with 1 USD when it traded at 1.03 on September 26) means that there are repercussions and changes for the US and global economy, making financial forecasting even more difficult.
Why is the US Dollar continuing to surge?
In a historic and unprecedented year for the USD, the dollar has been surging by an astonishing 17% in comparison to a group of other major currencies. The combination of the pandemic, global disruptions, inflation, and recession sentiment, means that it is very hard to predict as there isn’t really any other period like this to compare to.
However, there are a few main reasons behind a surging USD:
Geopolitical uncertainty- As has always been the case with economic and geopolitical uncertainty, countries around the world turn to the US dollar for stability. The combination of global economic disruptions and the war in Ukraine fits exactly this description. The world once again is turning to the American dollar, causing it to surge quite fast.
Rising interest rates- The Fed has been raising interest rates at breakneck speed, and has made it clear that they don’t plan on stopping until inflation has subsided. Raising interest rates in the US makes the US dollar stronger as bonds then produce higher returns. Other countries then turn to US currency due to the uncertainty of the global economy and the higher returns on bonds, all contributing to the growing strength of the USD.
The “best of the worst”– Despite the fact that the US economy is dragging the rest of the world into raising interest rates along with them and the US economy isn’t in great shape either, it’s doing far better than most EU countries, the UK, and Japan – all of whom are struggling even worse for a variety of reasons.
Implications on the US economy
For consumers and CFOs alike, the biggest implication of a stronger US dollar is that imports become cheaper and exports become more expensive.
On a broader scale, this means that the US trade deficit is increasing tremendously. A strong dollar means that US goods become more expensive for those outside the country, while foreign goods become cheaper for US citizens who then buy more imported goods. Before the pandemic, the trade deficit was running at around $50 billion a month, but now it’s more than double and sits at $110 billion a month, and growing.
On an individual scale, companies with big overseas earnings – such as Apple and Microsoft – blamed a strong US dollar as a major factor for their lower earnings in the second quarter. Many economists expect the 3rd quarter to continue to churn out lower earnings for large companies that rely heavily on overseas customers.
Marc Benioff, the CEO of Salesforce summed up how the strong dollar affects a company based in the US with an international customer base who buys in different currencies:
“We had a great quarter, but yet again, the dollar had an even stronger quarter.”
Benioff noted that in this fiscal year alone, a strong dollar is likely to cost the company more than $800 million!
A strong US dollar affects companies of all size companies, not just giant multinational corporations. Second quarter earnings increased by 10% from the same quarter in 2021, but earnings may have been around 12% if the US dollar wasn’t as strong.
In addition the Financial Times estimated that every 8% to 10% increase in the trade-weighted dollar index cuts S&P 500 returns by roughly 1%, affecting individuals and companies with assets in investments.
For US companies, as part of the world’s largest and most dynamic economy, a very small percentage of economic activity is dominated by trade (10%). Therefore, very few American companies of any size are completely dependent on international trade, however they are still dependent on imports, consumer sentiment, and international exchange rates.
For CFOs of any size based in any country, there are many ways that the strong US dollar can affect business and profits. While forecasting tools can help companies prepare for different scenarios, there two main things for CFOs to keep in mind for how a strong US dollar affects them directly:
- Consumer sentiment- After the Euro fell below a dollar and made headlines worldwide, it passed the line of a certain psychological threshold. Consumers and investors outside of the US are being more cautious and this is affecting many forecasts of companies of all sizes.
- Hedging- Companies that rely heavily on foreign currencies need to more seriously consider whether or not to hedge in a time like this when forex markets are all over the place. Hedging can help diversify risks with international currencies but can also be risky. Markets need to be carefully monitored, but hedging is becoming more of an attractive option for companies relying on foreign currencies.
The strong US dollar doesn’t seem like it’s getting weaker anytime soon. While this doesn’t necessarily hurt profits (depending on location, level of international reliance, imports/ exports, etc.) it’s still an important thing for finance teams to keep in mind. Consumer sentiment and all of its implications may affect profits and bottom line numbers so being prepared and understanding how it can affect your specific business is another thing to keep in mind in a tumultuous year.