What a Strong U.S. Dollar Means for Investors
Some company earnings could falter. Here's what to expect.
Key Takeaways
The strong dollar is driven by inflation in the United States. The U.S. Federal Reserve really was one of the first major central banks to really start tightening monetary policy in order to limit inflation.
If there is no change to inflation, the dollar will remain strong for the foreseeable future.
The strong dollar will cause companies that have a significant portion of their earnings coming from overseas to suffer most in their earnings.
Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. The U.S. dollar recently hit new two-decade highs after the Federal Reserve raised interest rates in September. Morningstar's chief U.S. market strategist Dave Sekera is here today to discuss what the strong dollar means for investors, company earnings, and stocks. Dave, let's start out talking a little bit about what's been driving the dollar's strength in 2022.
Dave Sekera: Well, there's been a number of different reasons, but first and foremost, from a fundamental point of view, I think it's because inflation in the United States, while we haven't turned the corner yet, at least has stopped going up. And the Federal Reserve here in the U.S. really was one of the first major central banks to really start tightening monetary policy in order to limit inflation. So, I think that from a fundamental point of view is one of the biggest reasons that we've seen the strength of the dollar, especially as inflation has been ramping up in the EU and the U.K.
I'd also say, from a more technical point of view, the other thing we've been seeing is that there has been a flight to safety to the U.S. dollar. So, again, while markets have been going down, both in the U.S. as well as internationally, the economic outlook globally has been pretty soft. That flight to safety has also helped push the dollar stronger.
Dziubinski: Do you expect the dollar to remain strong for the rest of this year?
Sekera Well, we don't explicitly forecast foreign exchange or the dollar in and of itself. We really stick to analyzing the fundamentals of the companies under our coverage. Now, having said that, I would say that in an environment that as long as inflation in the U.S. doesn't continue to start ramping back up and we do see inflation running hot in those other areas within the world, then yes, the dollar probably will remain strong for the foreseeable future.
Dziubinski: In a recent column that you wrote for morningstar.com, you talked a little bit about how a strong dollar can cause a threat to company earnings. Unpack that a little bit.
Sekera: Well, specifically, that's going to be for those global companies that have a lot of earnings in foreign jurisdictions, and essentially it's going to be what's called foreign-exchange currency translation, in accounting terms. Essentially that just means that when you have those earnings in a foreign currency generated overseas, when that company translates that back into U.S. dollars, for every amount of foreign currency that you have, you end up getting less dollars back in the United States. And so that will be a headwind to earnings growth for those companies.
Dziubinski: Dave, what types of companies tend to suffer the most when the dollar's strong?
Sekera: Well, again, as we mentioned earlier, it's those companies that do have a significant portion of their earnings coming from overseas. But from a fundamental point of view, more specifically, I'm also concerned about those companies that might have a mismatch between their revenue and their operating costs. For example, if their operating revenue is in U.S. dollars but then their costs would be in that foreign currency, you can see an expansion in their margins, which of course would be good for the company as the foreign currency is cheaper. Or conversely, if it's the opposite way around, and they're generating the revenue in that foreign currency, but their costs are in U.S. dollars, that then could actually impair and constrict their operating margins, which, of course, fundamentally could reduce the value of that company.