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All Eyes on the US Dollar

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From strength to weakness?

The US dollar has shown undeniable strength over the past year. The PowerShares DB US Dollar Bullish ETF (UUP) has returned over 17% in the period. At the same time, the CurrencyShares Euro ETF (FXE) has fallen over 19% in the last year.

With the euro having the biggest weight in the dollar index, the dollar rose from 76 around a year ago, to a peak of 93 in mid-March.

This strength was a cause of concern for companies like Groupon (GRPN), Pfizer (PFE), and Omnicom Group (OMC), who warned that the greenback’s strength would impact revenues in 2015. However, since mid-April, the dollar index has shown a nearly continuous fall.

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Impact of exports

Apart from currency investors, this news is important for companies that garner substantial revenues from exports. It also has much wider implications. This fall can relieve some pressure from exporters. If exports pick up, they will add to economic output as well. Apart from adding jobs, a pickup in economic activity can tighten the slack in the labor market. Job additions are usually followed by a boost in wages, leaving higher disposable income in the hands of American families.

As we saw in Part 4 of this series, consumer spending growth has been tepid. Even if consumers want to be cautious with their newfound jobs and the windfall from oil prices, after some time, they will regain confidence and acquire enough savings that can support some retail activity.

These events should reduce worries of policymakers, paving the way for a rate hike.

Impact of imports

One negative impact would be the higher cost of imports. Given that the US is a net importer of goods and services, a higher import figure will subtract from its economic output. For now, some weakness in the US unit should have a more positive impact than a negative one.

Consumers should be cautious, however. If Europe and Japan see signs of weakness again, their easing measures will persist and may even warrant an increase. This can put upward pressure on the dollar and the fallout of that, as described earlier in this article, will repeat itself. Although this may not necessarily stop policymakers from effecting a rate hike, the rate of increase would be much slower than anticipated.

Policymakers expressed their concern on term premiums in the minutes of April’s FOMC (Federal Open Market Committee) meeting. Let’s look at that in the next article.

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