The Strong US Dollar Effect on the US Economy, Earnings and Rates

The U.S. dollar has pulled back significantly from highs, 2023 had been the worst start for the dollar to the year since 2018 with the interest rate forwards feeding the pullback as they price in the terminal rate for the Federal Reserve to end its most aggressive program of interest-rate increases since the 1980s. In that period, we have seen two quarters of earnings and the lower dollar impact is noticeable. The strong dollar negatively affected multinational earnings and the US economic outlook and could alter the Federal Reserve terminal interest rate, economists surveyed by Bloomberg last year. Just 28% saw the currency strength as unlikely to have any impact. This was borne out in earnings.

We have seen some of those US dollar losses reverse in the second quarter of 2023 on two factors, safe haven buying and forward margins. Safe haven buying which will likely become intensified with the latest’s events in Russia with Wagner boss Yevgeny Prigozhin’s quixotic mutiny having fallen apart. The sending off of Prigozhin to exile without reprimand and no punishment of the rebels after labelling them traitors just hours before has set the pro Putin zealots off as lauding him as its only part of a genius plan. For the rest of Russia and the region it has but has left indelible doubts over Putin’s authority and his ability to prosecute the war. With that comes uncertainty, whichever is correct.

Geopolitically the landscape is constantly evolving since the Russian invasion of Ukraine, China’s Xi’s power grab and Covid lockdown protests, a move to the right in Italy and Russia’s annexation in eastern Ukraine of territories, after taking Crimea in 2014 and a divisive election in Brazil and the US deepening partisan divide.

Over the past few weeks, the Greenback has rebounded after being down about 8.5% from a peak last September, as measured by the US Dollar index or the WSJ Dollar Index. The Chinese Yuan has been particular weak with the PBoC meanwhile is trying to slow recent CNH weakness vowing to curb speculation following a drop to 7.0750, its weakest since December.

The Strong US Dollar Effect on US Economy and Rates

The survey of 40 economists was conducted Oct. 21-26.

  • 44% said they believed the Fed could fully complete its aggressive rate tightening despite possible stresses.
  • 38% said the policy makers would be forced to cut rates earlier than expected and
  • 18% said the Fed would not be able to raise rates as much as planned.
  • Survey respondents expect rates to peak at 5% early next year and a majority of the economists now expect a US and global recession.

The strong dollar is likely to negatively affect the US economic outlook and could alter the Federal Reserve terminal interest rate, economists surveyed by Bloomberg said. Just 28% saw the currency strength as unlikely to have any impact.

We identified that with the dollar oscillating lower on pricing of the end of the Fed’s tightening cycle, (that has reversed over the past few weeks) earnings have improved, at least the fore3x affects warnings at least. The move of the dollar came after a combination of short covering, higher interest rates and safe haven buying. These popular macro trades tend to be risk on or risk off and feed each other, the forex moves accordingly flow into other big shorts such as bonds, U.S. tech stocks, and commodities, and European equities.

The value of the dollar is an important component to lowering inflation. A stronger dollar tends to dampen inflation by reducing the costs of imports and lowering domestic production as it raises export prices.

We continue keep eyes on the bond market, as we have said the US 10-year Treasury peaked around 4.33% on the same day as the US dollar peaked against the yen USDJPY 151.95 on October 21.

“Usually the trade deficit would balloon when the dollar appreciated as much as we had seen since last year. But that effect has been curiously absent so far, even as we are already about five quarters into the appreciation process. One possible explanation is that US is increasing its exports in energy products. The fact that this tightening channel of dollar is absent means that the dollar appreciation is less contractionary to the economy than historically.”

Anna Wong (Bloomberg chief US economist)

The surge in interest rates and the de-risking of the world is one factor but there are other particular influences. With regards to volatility in currency markets, these huge moves act like rubber bands when its crowded. The more stretched an exchange rate is, the bigger, faster and more painful the eventual correction.

What is the catalyst?

There is the obvious, a peace deal in Ukraine or a dovish Fed, which after Chairman Powell’s speech at Jakson Hole that appears to need a dramatic change.

However, it is usually something not expected that creates major shifts. The reality is the recovery from the pandemic is not yet complete and we have the specter of a US recession darkening the scene. The strong dollar adds to the pressure to tighten as weak currencies exacerbate imported inflation.

To say central bankers, have issues is an understatement. Already grappling with the quickest inflation in decades they now have these decisions to make, forcefully raise borrowing costs to defend currencies and risk hurting growth, spend reserves that took years to build to intervene in foreign exchange markets, or simply stand aside and let the market play out.

John Maynard Keynes, 1920: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction and does it in a manner which not one man in a million is able to diagnose.”


For a Complete Macro and Micro Market Overview Visit TC Traders Market Weekly

Sources: TC WSJ Bloomberg

Trade Smart

From The TradersCommunity Research Desk