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For Wall Street, a Strong Dollar Is Front and Center
Investors are increasingly concerned that the rising U.S. currency will strain other economies
By Julia Ambra-Verlaine
The strong dollar is now one of Wall Street’s main concerns.
On Main Street, a rising dollar boosts Americans’ relative purchasing power by making imports cheaper. But the dollar is also at the center of world financial markets, and a stronger U.S. currency can have unforeseen consequences.
Investors and policy makers are being forced to consider history’s unkind lessons. Currency shifts were behind the 1997 Asian financial crisis and played a role in the Russian financial crisis of 1998, which took down giant U.S. hedge fund Long-Term Capital Management.
This year has been quite a year for the dollar. With stocks and bonds both falling, investors looking for havens have scooped up the U.S. currency. The dollar has gained 17% against the pound so far this year, and it climbed past parity with the euro for the first time in two decades. The WSJ Dollar Index, which measures the dollar against a basket of other currencies, is up 13% year to date.
Here are five main places where the dollar’s strength could become a problem.
Emerging Markets
As the world’s reserve currency, the dollar is used to trade commodities across country lines. Emerging-markets economies are vulnerable to the dollar’s strength in part because they attract money from international investors and often price their debt in dollars.
A stronger dollar often makes emerging-markets currencies less valuable. That in turn exacerbates inflation in those countries, by making it more expensive to import goods and services.
Earlier this year, emerging markets remained resilient even as the dollar rallied. But that was largely because commodities prices were rising, boosting countries that export copper, soybeans and coffee. Now commodities prices are falling, and global economists say trouble could lie ahead for emerging markets.
Corporate Earnings
U.S. corporations involved in international business have cut earnings guidance since June, citing the dollar’s gains. Microsoft Corp. was one of the first to raise red flags. Deere & Co., the farm-machinery supplier, also warned that a stronger dollar would strain future profits.
That has translated into stocks, where companies with large sources of foreign revenue took a hit earlier this year—including Apple Inc., Google parent Alphabet Inc., and chip maker Nvidia Corp. While the market has rebounded since then, more companies are sounding the alarm, which could mean extra pain ahead for stock investors.
The Global Economy
Global central banks are in a race to tighten monetary policy to try to curb inflation—but the rising dollar is complicating their job.
“A stronger dollar makes tackling inflation in Europe very hard for a number of reasons,” said Keith DeCarlucci, chief investment officer at London-based hedge fund Melqart KEAL Capital. “The most important goods they trade, including energy, are priced in dollars.”
If central bankers raise interest rates too quickly, they risk recession. But investors tend to reward the countries whose central banks act most aggressively to curb inflation. The Federal Reserve’s swift tightening is one reason that the dollar has soared this year.
Policy makers in Australia and Canada increased interest rates in recent weeks. The European Central Bank raised rates on Thursday by the largest amount since the early days of Europe’s currency union.
Currency Intervention
Some are worried that continued dollar strength might push governments to intervene even more directly to shore up their currencies, perhaps by selling dollars to buy their own currencies or abandoning pegs to the dollar.
That can work, though it is more likely to do so if the U.S. joins in. In 1985 the U.K., France, West Germany and Japan joined the U.S. in the Plaza Accord, which aimed to bring down a dollar whose gains were perceived as unhealthy. While most Wall Street analysts say such an intervention is unlikely in the current political landscape, some say the option isn’t off the table.
Treasury Secretary Janet Yellen has pushed back against this idea, though. “In general our view is that countries like Japan, the United States, the G-7 should have market-determined exchange rates and only in rare and exceptional circumstances is intervention warranted,” Ms. Yellen said in July at a meeting in Tokyo with Japanese officials.
US Dollar Funding
Money managers are closely tracking whether dollars are growing scarce in an arcane funding market known as cross-currency basis swaps. When volatility rises, investors sometimes hoard dollars.
In March 2020, for example, dollar-funding markets seized up, prompting the Fed to launch a lending facility that allows foreign central banks to convert their holdings of Treasury securities into dollars.
The so-called swap lines are meant to ensure that dollars are available to other central banks during periods of market stress.
While a global tightening cycle could reduce inflation in the U.S. by strengthening the exchange rate, Fed officials are always “carefully looking to see if there are some financial-stability risks out there,” Fed Vice Chairwoman Lael Brainard said at a recent banking conference in New York.
—Nick Timiraos contributed to this article.
