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Implications of a rising US dollar

New York, 05 Nov 2015

Steady growth in the US jobs market and an increasingly strong domestic economy has led to a sustained strengthening of the US dollar over the last two years.

Since 2013 the Australian dollar has fallen 24 per cent against the US, the Japanese Yen has depreciated 20 per cent, and the Euro has fallen by 16 per cent.

Now more than ever, foreign exchange movements are important for both companies and individuals.

Globalisation means revenues, costs and investment exposures are increasingly denominated across various currencies, and changes can have significant consequences. 

Understanding why currencies move and available hedging strategies can help to manage downside risk while participating in upside exposure. 

The US dollar’s appreciation has been fuelled by a number of factors, including more positive data coming out of the US, says Macquarie's New York based Foreign Exchange and Interest Rates Strategist, Thierry Wizman.

“Importantly, the US jobs market is showing steady signs of recovery. US unemployment fell to 5.1 per cent in September 2015, down from 5.7 per cent in January 2015 and has almost halved from the high of 10.0 per cent in October 2009.”

When the labour force grows, so too does an economy’s demand for goods and services, therefore prices or inflation.

“We have seen persistently low inflation in the US through 2015, which has been at or hovering around zero, well below the Federal Reserve’s target of two per cent. With the renewed trend towards lower unemployment there is general optimism toward a flow-on effect to rising inflation.

This optimism is evidenced via the growing consensus of an impending policy interest rate rise by the US Federal Reserve in December. Consensus which heightened recently after the Fed kept the policy interest rate on hold at their October Open Market Committee meeting.

Now more than ever, foreign exchange movements are important for both companies and individuals.

Foreign monetary policy conditions have also contributed to the US dollar’s strength, says Wizman.

“Loose monetary policy conditions set by foreign central banks of the US’ key trading partners have contributed to capital flight, resulting in relative weakness of their respective local currencies.”

While currencies such as the Euro and Japanese Yen have close correlation with the US dollar, the Australian dollar is considered a commodity currency. Its value is strongly correlated to the price of its chief raw material exports, namely iron ore and coal. Demand for commodities from key importers therefore plays a significant role in determining its value.

“Accounting for 27 per cent of total exports, China is Australia’s largest export market. A recent slowdown in Chinese economic growth has seen a similar decline in the dollar, depreciating this year from a high of 82 US cents in January to around 70 US cents in November”, says Wizman.

In an ever interconnected global economy, foreign exchange fluctuations are relevant and impact almost all facets. In particular, companies whose revenues and costs are denominated in different currencies.

“The effects of the stronger US dollar will have been felt most adversely by foreign corporations that earn revenue at home in their local currency, and that have borrowed in US dollars. The same holds true for US-based investors earning income abroad, for example global real estate managers who have diversified portfolio exposure to international markets.”

“Conversely, due to the inverse relationship between commodity prices and the US dollar, companies that buy global commodities such as airlines purchasing fuel, will likely have benefited from the dollar’s strength.”

Various risk protection strategies can be implemented by companies as well as individuals to hedge against foreign exchange fluctuations, including forward contracts and call option spreads.

“With sound advice and expertise, hedging strategies can add significant value in managing foreign exchange exposure risk, particularly in uncertain or volatile times”, says Wizman.

“And with the Fed set to meet for a final time this year in December, a smart and timely strategy could make a big difference.”

Learn more about Macquarie’s expertise in foreign exchange, and our capabilities in the Americas.