On January 16, 2015, the U.S. dollar reached an 11-year high in its value against the euro — part of a trend that has seen the value of the dollar rise steadily against the currencies of major U.S. trading partners since mid-summer 2014.1–2 Not coincidentally, the price of oil has dropped sharply during the same period (see chart).
It would seem that a strong dollar is good for the U.S. economy. However, the outlook is more complex than it may appear. As a consumer and investor, you might take a moment to consider the causes and potential effects of the rising dollar.
Weakness Overseas
Fundamentally, the dollar is rising because the U.S. economy is gaining strength while many foreign economies are struggling. Investors, including foreign governments, generally prefer to hold a stronger currency. The potential for U.S. interest rates to rise in 2015, at a time when other central banks are taking steps to ease rates, makes the dollar even more appealing.3
In the third quarter of 2014, the period when the dollar’s value began to rise, U.S. gross domestic product (GDP) increased at a 5.0% annual rate.4 By contrast, eurozone GDP increased just 0.8%, and Japan’s economy shrank by 1.2%. China continues to grow at a faster rate than the West, but its growth has slowed.5
Dollars for Oil
Global oil is priced in dollars, so a strong dollar tends to push prices down. When a dollar is worth more, a lower dollar-denominated price may provide the same value in oil.6
In the current situation, the primary forces driving down the price of oil are increased U.S. production and weaker global demand. The strong dollar adds to the downward trend through the price/value relationship and by making it more expensive for weaker economies to buy the oil they need to grow, thus further reducing demand.7 At the same time, falling oil prices negatively impact the profits and currencies of oil-exporting countries, further strengthening the dollar.8
Trade Imbalance
A strong dollar is likely to cut into U.S. exports by making American products more expensive overseas, and to increase imports by reducing the cost of foreign goods. The effects of a widening trade gap will take time to unfold, and opinions vary about how significant this may be for our economy.9
One trade expert suggested that a decline in exports could slow the recovery and lead to the loss of half a million U.S. jobs in 2016, whereas other experts believe that the boost from falling oil prices may offset the loss of export income.10
Federal Reserve officials have emphasized that exports are a relatively small part of the U.S. economy and that other factors, including cheaper oil, point to continued economic growth.11
Weaker exchange rates against the dollar might help some U.S. trading partners increase their own exports and give their struggling economies a boost. If this occurs, a stronger global economy could help balance any negative effects of the strong dollar.12
Consumer Upside
According to one estimate, U.S. households could realize a $700 average gas savings during 2015.13 More consumer discretionary income could boost retail sales, which play a key role in the larger U.S. economy.
Cheaper imported goods might also help American families. However, foreign-exchange savings may not always be passed on to consumers. Foreign travel should be a bargain as long as the dollar remains strong, especially if U.S. travelers purchase goods and services in the currency of the country they are visiting.
Investment Climate
The strong dollar, falling oil prices, and economic weakness outside the United States have already affected the U.S. stock market and likely will continue to do so. However, the effects may vary widely among different business sectors and individual companies within each sector.14 There is no reason to shift away from an appropriate long-term strategy, but you might keep a careful eye on specific investments.
In a global economy, strength or weakness in one region may influence others in ways that cannot always be anticipated. It remains to be seen whether stimulus efforts by foreign central banks will help lift their economies out of the doldrums.
For now, the pressing question is whether the fundamental strength of the U.S. economy can push through any headwinds caused by the strong dollar and weakness among our trading partners.
All investments are subject to market fluctuation, risk, and loss of principal. Investments, when sold, may be worth more or less than their original cost.
1) Bloomberg, January 16, 2015
2, 11) Federal Reserve, 2014–2015
3, 8) Financial Times, December 31, 2014
4) U.S. Bureau of Economic Analysis, 2014
5) Organisation for Economic Co-operation and Development, 2015
6) Yahoo! Finance, December 19, 2014
7) Business Insider, October 22, 2014
9–10, 12) The Wall Street Journal, January 6, 2015
13) cnbc.com, January 9, 2015
14) CNNMoney, January 6, 2015
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.
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