Is the U.S. super-dollar effect no more?

Trade weighted US dollar index

Despite widespread expectations (and fear) that the U.S. dollar would strengthen considerably this year as the Trump administration assumed power and the Federal Reserve moved forward with an accelerated tightening cycle, the dollar has weakened by 1.8% since the beginning of 2017, according to a widely used trade-weighted currency index. Though the dollar is still stronger than pre-election levels, this is a far cry from the fear that the global economy would be confronted by a “super-dollar”, which would negatively impact the export competitiveness and margins of U.S. multinationals while endangering economic stability in vulnerable developed and emerging markets.

Why the dollar has stalled

The major drivers of the limited appreciation of the dollar against most other major currencies are the following:

  • Trump agenda’s diminished prospects: President Trump’s policy agenda, which included comprehensive tax reforms and increased infrastructure spending, now seems significantly less likely to pass, reducing expectations of major stimulus-driven GDP growth (driving higher financial inflows into the US) and higher inflation (which would’ve led the Fed to pursue an accelerated rate hike cycle)
  • Stronger European economic performance: As FSG has noted, Western European markets are experiencing a solid cyclical rebound in GDP growth, led by Germany and Spain. Healthier economic performance in the largest markets of the Eurozone have led to reduced expectations for monetary policy divergence between the Federal Reserve and the European Central Bank, which has alleviated upward pressure on the dollar against the euro

Why the dollar remains likely to strengthen over the rest of 2017

While the changing market conditions will reduce the pace of the dollar’s climb, multinationals should still expect the dollar to gain against most currencies this year. Inflation, long-standing Fed policy, and the persistent threat of global disruptors make for a bullish case in favor of the U.S. dollar:

  • The Fed is still likely to tighten monetary policy: FSG expects at least two more rate hikes in 2017, with the potential for the Fed to begin winding down its balance sheet if U.S. economic conditions remain stable and, most significantly, if inflation continues to rise. Further rate hikes or balance sheet sell-offs by the Fed will boost the dollar, with emerging market central banks likely to confront challenges over how to respond without constraining economic growth
  • Potential for disruption remains elevated: Persistent uncertainty over US trade policy, elections in Europe, and China’s economic and financial stability will continue to threaten the economic outlook despite a somewhat improving global growth environment. This will put continued pressure on emerging markets, which will be felt first-and-foremost through a strengthened U.S. dollar

Executives with international responsibility will need to continue to carefully monitor foreign exchange volatility and develop appropriate contingency planning and hedging strategies to mitigate the impact of a strengthening U.S. dollar on performance.

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