What is dollar strength & who invests in it?
You may have heard that the dollar is “strong” right now. You may have also heard that a strong dollar amounts to a headwind against commodities and stocks.
—Kevin B. Perlberg, CFP®
While there is some truth to that, there is more to the story. A strong dollar does not necessarily rein in the bulls, and dollar strength can work for the economy and the markets.
The U.S. Dollar Index has soared lately. Across July 2014-February 2015, the USDX (which measures the value of the greenback against key foreign currencies) rose an eyebrow-raising 19.44%.1
On March 9, the European Central Bank initiated its quantitative easing program. The dollar hit a 12-year high against the euro a day later, with the USDX jumping north more than 3% in five trading days ending March 10. Remarkable, yes, but the USDX has the potential to climb even higher.2,3
Before this dollar bull market, we had a weak dollar for some time. A dollar bear market occurred from 2001-11, partly resulting from the monetary policy that the Federal Reserve adopted in the Alan Greenspan and Ben Bernanke years. As U.S. interest rates descended to historic lows in the late 2000s, the dollar became more attractive as a funding currency and demand for dollar-denominated debt increased.4
In Q1 2015, private sector dollar-denominated debt hit $9 trillion globally. Asian corporations have relied notably on foreign currency borrowing, though their domestic currency borrowing is also significant; Morgan Stanley recently researched 625 of these firms and found that dollar-denominated debt amounted to 28% of their total debt.4,5
So why has the dollar strengthened? The quick, easy explanation is twofold. One, the Fed is poised to tighten while other central banks have eased, promoting expectations of a mightier U.S. currency. Two, our economy is healthy versus those of many other nations. The greenback gained on every other major currency in 2014 – a development unseen since the 1980s.4
This explanation for dollar strength aside, attention must also be paid to two other critical factors emerging which could stoke the dollar bill market to even greater degree. At some point, liabilities will increase for the issuers of all that dollar-denominated debt. That will ramp up demand for dollars, because they will want to hedge.