The value of the US dollar has been skyrocketing for over a year against all currencies, from the pound sterling across the Atlantic to the South Korean won across the Pacific.
After rising again on Friday, the dollar is near its highest level in more than two decades, according to an index measuring six of the major currencies, including the euro and the Japanese yen. Many professional investors don’t expect it to slow down anytime soon.
The dollar’s rally affects virtually everyone, even people who would never leave US borders. Let’s examine what is causing the US Dollar to rise and what it could mean for investors and families.
Dollar hits 20-year highs
What does it mean to say that the dollar is more appreciated?
Essentially, that a dollar can buy more of another currency than it could before.
Consider the Japanese yen. A year ago, a dollar could buy just under 110 yen. It can currently buy 143. That’s about 30% more, and one of the biggest changes the US dollar has undergone against another currency.
The values of foreign currencies are constantly changing relative to each other as banks, companies and investors buy and sell currency in different time zones across the world.
The US Dollar Index (DXY), which compares the dollar to the euro, yen and other major currencies, is up more than 14% this year. The gain looks even more impressive compared to other investments, which have mostly had a dismal year. The US stock market has dropped more than 19%, bitcoin has fallen by less than half, and gold has lost more than 7%.
Why is the dollar getting more appreciated?
Because the US economy is doing better than the others.
Although inflation is high, the US labor market has remained fairly stable. And other areas of the economy, such as the service sector, have been resilient.
That helps offset concerns about slowing housing and other parts of the economy that do better when interest rates fall. This, in turn, makes investors continue to expect the US Federal Reserve, the Fed, to fulfill its promise to continue to raise interest rates intensely and keep them at that level for some time, seeking to control the worst. inflation of the last 40 years.
Those expectations helped the yield on a 10-year US Treasury bond rise from roughly 1.33% a year ago to 3.44%.
Who cares about bond yields?
Investors who want more return on their investment. And these higher US bond yields are attracting investors from around the world.
Other central banks have been less aggressive than the Fed because their economies appear more fragile. The European Central Bank has just made the biggest-ever increase in its base rate, by three-quarters of a percentage point.
But the Fed has already made that same increase in its base rate twice this year, and a third increase is expected next week. Some investors say even a gigantic one-percentage-point increase is possible, in the wake of a more worrying-than-expected report on US inflation on Tuesday.
Partly because of this less aggressive trend, 10-year bonds in Europe and other parts of the world offer much lower yields than US Treasuries, such as 1.75% in Germany and 0.25% in Japan. . When Asian and European investors buy US bonds, they have to exchange their own currency for US dollars. This boosts the value of the dollar.
Does an appreciated dollar help American tourists?
Yup. American travelers in Tokyo who spend 10,000 yen on a dinner will be using 23% less dollars than they would have spent a year ago on a meal of the same value.
With the dollar rising sharply this year against all currencies from the Argentine peso to the Egyptian pound and the South Korean won, the US currency is offering more than ever before in many countries.
Is it only useful for wealthy Americans who can travel abroad?
Not. A stronger dollar also helps US consumers by keeping import prices in check and pushing inflation down.
When the dollar rises against the euro, for example, European companies earn more euros for every dollar in sales. With this mattress, they could reduce the dollar price of their products and still earn the same amount of euros. They could either keep the price in dollars and pocket the extra euros, or they could strike a balance between the two.
US import prices fell 1% in August from a month earlier, after falling 1.5% in July, offering some relief amid the country’s high inflation. Prices of fruits, nuts and some shells fell by 8.7%, for example. They are 3% lower compared to the previous year.
A stronger dollar can keep commodity prices in general in the US under control, because oil and gold, among others, are bought and sold in dollars around the world. When the dollar rises against the yen, a Japanese buyer may receive fewer barrels of crude oil for at least number of yen than before. As a result, there may be less pressure on the price of oil.
So everyone wins when the dollar appreciates more?
Not. The profits of US companies that sell abroad are being flattened.
McDonald’s revenue during the summer was down 3% from a year earlier. However, if the value of the dollar in relation to other currencies had been maintained, the company’s revenue would have been 3% higher. Microsoft, meanwhile, says currency changes took away $595 million of its earnings in the last quarter.
A number of other companies have issued similar warnings recently, and a further rally in the dollar could cut profits further. According to financial data firm FactSet, companies listed on the S&P 500 get about 40% of their revenue from outside the United States.
Are there other collateral damages?
A stronger dollar could create a financial squeeze for developing countries. Emerging market companies and governments often borrow in dollars, rather than their own currency. When they need to pay off debts in dollars, while their currencies buy fewer and fewer dollars, the situation can become worrying.
What is the fate of the dollar from now on?
The dollar’s biggest moves may be over, but many experts expect it to remain at least at its current appreciation for some time.
Tuesday’s US inflation report startled the market and showed it remains more resilient than expected. As a result, investors have increased bets that the Fed’s interest rate will rise by next year. Fed officials have been reaffirming their commitment to keeping rates high until “the job is done” to defeat high inflation in the country, even as economic growth suffers.
This trend by the Fed towards even higher rates should continue to support the dollar’s appreciation.
For the dollar to devalue significantly, some experts wrote in a Bank of America Global Research report, “the Fed would need to start worrying more about growth than inflation — and we’re not there yet.”