What A Strong Dollar Means – Currency Overview

The U.S. dollar has risen over 4% since mid-April, driven by increasing interest rates and growing confidence in the U.S. economy. An expanding economy tends to generate inflationary pressures that lead to higher interest rates.

A stronger dollar can also be a hindrance for certain U.S. companies that have a large portion of their sales overseas. Should the dollar continue on its elevated trend, economists and analysts believe that the run up in the dollar will translate into lower earnings for a number of U.S. companies. Foreign investors tend to flock to the U.S. dollar as rates increase, seeking higher returns on idle cash from all over the world.

A challenge for U.S. multinationals when the dollar rises is the price of U.S. exports becoming more expensive worldwide. As the dollar increases in value versus other currencies, U.S. exported goods become less affordable in the international markets.

Conversely, the strengthening dollar has also made it more affordable for imported goods, which become less expensive as the dollar elevates. The single most significant benefit to Americans from a rising dollar has historically led to a drop in oil prices, which the U.S. still imports about a third of the oil consumed. But over the past few weeks, oil and gasoline prices have been rising, a diversion from previous dollar rallies.

Since nearly all commodities worldwide are traded in the U.S. dollar, a stronger dollar tends to lower the price of commodities internationally. Consequently, lower commodity prices tend to be negative for countries whose economies are dependent on commodity exports.

Sources: https://fred.stlouisfed.org/, Bloomberg, Commerce Department

Could Italy Be The Next Greece – International Update

Italians are expected to cast votes in an upcoming election that may entail a referendum to exit the eurozone. Should such a vote occur, it would be similar to Britain’s vote to exit the eurozone in 2016, also known as Brexit. Italy is the third largest member of the eurozone in terms of population and economic status, making an exit from the eurozone an instrumental blow to the financial and political stability of the region.

The recent news from Italy is reminiscent of the Greek Credit Crisis that lingered on for nearly 6 years until a resolution with the IMF was agreed upon in 2016. Nearly six years ago, the eurozone was on the brink of a breakdown when Greece and other smaller economies of the region were in a serious debt crisis. Moody’s Rating agency downgraded Italy’s credit rating two notches above junk status, making it more expensive for the country to borrow.

A rising dollar has hindered emerging markets as their dollar-denominated debt has become more costly to repay. The Institute of International Finance estimates that emerging markets held a record $6.3 trillion in dollar-denominated debt at the end of 2017. Rising U.S. interest rates can also entice international investors to extract assets from emerging countries and migrate them to U.S. assets such as Treasuries.

Sources: Eurostat, IMF, Institute of International Finance

Volatility Eases – Domestic Equity Overview

Market volatility eased in May as earnings solidified fundamentals and fostered some confidence among equity investors. Small capitalization stocks reached new highs in May, out pacing their larger cap peers. Such an occurrence is a validation to equity analysts that broad-based fundamentals are in place.

Several analysts believe that the recent tax cut laws that became effective in January 2018, have been helping to accelerate the realization on some equity capital gains, essentially driving tax revenue growth.

A healthy decline in junk bond defaults is considered beneficial for equities as it implies strong underlying fundamentals for U.S. companies, as noted by Moody’s. The credit rating agency projects that the default rate for high yield bonds will fall to 1.5% by April 2019, down from 3.7% in April 2018. With oil sector bonds making up a large portion of the current high yield market, rising oil prices have solidified oil industry balance sheets and improved cash flow, all beneficial for equity valuations.

Sources: Reuters, Bloomberg, Moody’s