The US dollar has reached 20-year highs and its impact is felt across the globe. The effects are both positive and negative though, as it is still the world’s reserve currency and its influence is felt far and wide.
The strong US dollar
The US Dollar Index, which measures the strength of the US dollar against six major currencies, hit 110 last week, a 20-year high against major currencies. Key levels were broken for the yen (140), euro (1.00), and pound (1.15).
The factors strengthening the US dollar are two-sided. There are higher US interest rates and global risk aversion boosting the dollar, and there is an energy crisis and highly negative real interest rates which are depressing other currencies. The Brazilian Real (BRL) and Russian Ruble are the only major currencies that have gained on the dollar this year.
A strong dollar’s negative impacts
The stronger dollar has plenty of negative impacts which are tightening financial conditions across the planet. In emerging markets (EEM), the strong dollar is making raising financing more difficult and increasing the debt of countries. For commodities (DJP), it makes them more expensive in local currency terms and, therefore, lowers demand. For US tech (XLK), a stronger dollar makes their products less competitive abroad, as 60% of their sales come from abroad, the most of any sector. It also makes the inflation battle harder for the rest of the world because anything paid against the dollar is now at a higher price. For example, oil.
Britain and the dollar
Sterling (GBP) has been showing weakness recently. The current UK account deficit is at record highs and new government spending plans to increase the fiscal deficit above 5% of GDP. Despite that, the freely floating exchange rate and having all its debt in GBP is a cushion.
Nonetheless, the weakening of the pound will make life more uncomfortable for consumers as items such as gasoline, US intellectual property from movies to music, and US holidays are all more expensive because they are all priced in US dollars. The silver linings are the benefits to inbound tourism and high-end property, which will now be more attractive for those paying in dollars. There is still potential for the pound to weaken even more.
Benefits for exporting companies
Weaker currencies can help export-focused company competitiveness. Especially in the UK, Europe, and Japan that are full of these stocks, and export products in dollars. In these cases, being able to operate with dollars, as opposed to the weaker local currency, is a big boost. This has helped make the overseas-focused FTSE 100 the best performing major equity index this year. For the US, inflation would be even worse without the strong dollar, since companies importing goods are paying less and, therefore, they are priced more cheaply. This has helped support the recent inflation peak and outlook for a Christmas end to the Fed hiking cycle.