The US dollar has been rising for more than 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 that measures six major currencies, including the euro and the Japanese yen. Many professional investors don’t expect that to slow down anytime soon.
The dollar’s rally affects almost everyone, even people who don’t leave US borders. Let’s examine what’s driving the US dollar’s rise and what it means for investors and households.
The dollar hit a 20-year high
What does it mean to say that the dollar is overvalued?
Basically, one dollar can buy more of another currency than before.
Consider the Japanese yen. A year ago, a dollar could buy less than 110 yen. You can currently buy 143. That’s up about 30%, one of the biggest moves the US dollar has made against another currency.
The values of foreign currencies are constantly changing as banks, companies and investors buy and sell the currency in different time zones around the world.
The U.S. dollar index (DXY), which compares the dollar to the euro, yen and other major currencies, is up 14% this year. This gain looks impressive compared to other investments, which have often had a bad year. The US stock market is down more than 19%, Bitcoin is down less than half and gold is down more than 7%.
Why does the dollar appreciate?
Because the US economy is doing better than other countries.
Despite high inflation, the US labor market remains fairly stable. Other sectors of the economy, such as the service sector, are resilient.
That helps offset concerns about housing, which performs better when interest rates fall, and slowing other parts of the economy. In turn, investors expect the U.S. Federal Reserve, the central bank, to continue raising interest rates and keep its promise to keep them at those levels for some time, the worst inflation of the past 40 years.
Those expectations helped lift the yield on the 10-year U.S. Treasury note to 3.44% from about 1.33% a year ago.
Who cares about bond yields?
Investors expect high return on their investment. And these high US bond yields are attracting investors from around the world.
Other central banks are less aggressive than the Fed because their economies are more fragile. The European Central Bank has made its biggest ever increase in its base rate by three quarters of a percentage point.
But the central bank has already made the same hike in its base rate twice this year, and a third increase is expected next week. On the back of a more worrisome-than-expected report on U.S. inflation on Tuesday, some investors say even a massive one-percentage-point increase is possible.
Because of this less aggressive trend, 10-year bonds in Europe and the rest of the world offer much lower yields than U.S. Treasuries, such as 1.75% in Germany and 0.25% in Japan. When Asian and European investors buy US bonds, they must convert their own currency into US dollars. This increases the value of the dollar.
Will a Valued Dollar Help US Tourists?
Yes. American travelers spending ¥10,000 on dinner in Tokyo will use 23% fewer dollars than they spent on a meal of the same value a year ago.
As the dollar has risen sharply this year against everything from the Argentine peso to the Egyptian pound and the South Korean won, the U.S. currency is offering more than ever in many countries.
Is it only useful for wealthy Americans who can afford to travel abroad?
No. A strong dollar helps US consumers by keeping import prices in check and reducing inflation.
When the dollar rises against the euro, for example, European companies earn more euros for every dollar in sales. With this cushion, they can lower the dollar cost of their products and still make the same amount of euros. They can keep the price in dollars and pocket the extra euros, or strike a balance between the two.
After falling 1.5% in July, US import prices fell 1% in August from a month earlier amid the country’s high inflation. Prices of fruits, nuts and some shells fell by 8.7%. They are 3% less than the previous year.
A strong dollar can generally keep commodity prices in check in the U.S., because things like oil and gold are bought and sold in dollars around the world. When the dollar rises against the yen, a Japanese buyer can get fewer barrels of crude oil for fewer yen than before. As a result, there may be downward pressure on oil prices.
Does everyone win when the dollar appreciates?
No. Profits of American companies selling overseas are flat.
McDonald’s revenue for the summer was down 3% from a year earlier. However, had the value of the dollar been maintained against other currencies, the company’s revenue would have been 3% higher. Microsoft, meanwhile, says currency changes took $595 million off its revenue last quarter.
Several companies have recently issued similar warnings that a further rally in the dollar could further erode profits. According to financial data firm FactSet, companies listed in the S&P 500 derive 40% of their revenue from outside sources. America.
Are there other collateral damages?
A strong dollar can create a financial crisis for developing countries. Emerging market companies and governments often borrow in dollars rather than their own currency. When they have to pay their debts in dollars, and their currency buys fewer and fewer dollars, the situation becomes alarming.
What is the future of the dollar?
The dollar’s biggest moves may be over, but many experts expect it to stay at least at its current valuation for a while.
Tuesday’s US inflation report spooked the market and showed it was more resilient than expected. As a result, investors are betting that the central bank will raise interest rates within the next year. Central bank officials have reaffirmed their commitment to keep rates high until “the job is done” to beat the country’s high inflation, even as economic growth suffers.
This move by the central bank toward even higher rates should continue to support the value of the dollar.
For the dollar to depreciate significantly, some experts wrote in a Bank of America Global Research report that “the central bank needs to start worrying more about growth than inflation — and we’re not there yet.”
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