Being strong is not necessarily a blessing at all times. Ask US exporters whose businesses have suffered because of the US dollar’s strength against its peers. The PowerShares DB US Dollar Bullish ETF (UUP) is up ~17% from a year ago while the CurrencyShares Euro Trust ETF (FXE) is down ~18% in the same period. Plus, the CurrencyShares Japanese Yen Trust ETF (FXY) has fallen 18.6%. But why this strength?
Part of the answer lies in the contrasting monetary policies being followed in the regions. While the US is looking at hiking its interest rates, Europe and Japan continue practicing monetary easing. They may even expand it if circumstances dictate. A currency usually strengthens while the contractionary monetary policy is about to begin while losing value at hints of expansionary policy.
Both, Europe and Japan are important trading partners of the US. If the value of currencies in their respective geographies remains low, European and Japanese customers would prefer to opt for cheaper domestic products, rather than buying expensive imported substitutes. Of course, the quality of products and services is also a factor, but when people don’t have jobs or money, they often prefer quantity over quality.
Why should you track the US dollar?
The Federal Reserve does not explicitly track the US dollar while deliberating on the path of monetary policy. However, as we have seen in this and the previous article, the dollar’s status can show up in US economic output in the form of net exports.
If the dollar loses some of its strength, exporters like ExxonMobil (XOM), Honeywell International (HON), Colgate-Palmolive (CL), and Oracle (ORCL) would be pleased, as would be the overall US economic output.
Next, let’s return to analyzing economic indicators and their levels required for a rate hike—inflation is next.