Pros and cons of strong dollar
If you treat yourself to a trip to Paris for the holidays, you’ll pay less to toast the New Year than you would have last year.
The dollar is the strongest it has been in decades against the euro, British pound and Japanese yen. Many emerging-markets currencies have plummeted to all-time lows against the dollar.
Global travelers can thank the Federal Reserve, which has been raising interest rates in an effort to combat inflation. Higher rates make investments in Treasury bonds more attractive to investors, increasing the value of the dollar. Although the Fed’s goal is to curb inflation by slowing economic growth, the U.S. economy is still strong on a relative basis, which contributes to the dollar’s strength. The pandemic plunged many countries’ economies into recession, but the U.S. recovered much more quickly than the rest of the world, says Mark Zandi, chief economist for Moody’s Analytics.
Global turmoil has also contributed to the dollar’s strength. Russia’s invasion of Ukraine, along with the eurozone’s dependence on Russia for energy, has led investors to view the U.S. as a safe haven, says Kathy Jones, chief fixed-income strategist at the Schwab Center for Financial Research. “We have the largest and most liquid risk-free market in the world,” she says. “A lot of foreign investors, whether they’re pension funds, insurance companies or foreign governments, prefer to put their money in U.S. dollar-denominated securities.”
Even if you don’t plan to travel overseas any time soon, you may benefit from the strong dollar. A strong dollar lowers the price consumers pay for imported goods. “Walk in any Walmart, and pretty much everything you see will be less expensive,” Zandi says.
But there are downsides to a robust buck. When the dollar is strong, foreign consumers pay more for the products the U.S. exports, which hurts multinational companies that derive a significant percentage of their revenue from other countries. Companies in the benchmark S&P 500 index generate about 30% of their revenues outside the U.S., according to investment firm LPL Financial, and profits decline when they’re translated from weak currencies to dollars.
Emerging markets have been particularly hard hit by the strong dollar. Many of those countries’ corporate and government bonds are denominated in dollars, and when the dollar rises, it increases the cost of servicing those debts. The dynamic may be even more severe this time around, Jones says, because emerging-markets countries issued dollar-denominated debt over the past few years when borrowing costs were low and investors were eager to take more risks in exchange for higher yields. Now those emerging-markets borrowers are faced with the task of servicing that debt with a combination of weaker currency and higher interest rates. That has raised the risk of downgrades or outright defaults on some of those debts.
How long? Kiplinger forecasts that the dollar will remain strong through 2022, and it could retain its dominance well into next year. Jones expects to see a slowdown in appreciation, but says the dollar will likely remain strong against other currencies into 2023 because the underlying causes aren’t expected to change anytime soon. She adds that there continue to be few attractive alternatives to the U.S. dollar for foreign investors.