The Trade-Weighted US Dollar has risen almost 19% over the past 18 months - the fastest pace of increase on record - and is now at its highest level since 2003. As we noted previously, this is not unequivocally good for American corporate profits... and if you believe The Fed's Stan Fischer - the worst effects of this soaring exchange rate are yet to come... Most of the impact of exchange rate moves come after that first year. So we’re only just getting into the business end of the impact of the dollar’s strength on the US economy. And the Fed are about to hike?
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As BlondeMoney's Helen Thomas noted recently [11], take the recent speech [12] from Stan Fischer on ‘The Transmission of Exchange Rate Changes to Output and Inflation‘.
For a 10% appreciation in the US dollar:
‘The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years. Moreover, the effects materialize quite gradually, with over half of the adverse effects on GDP occurring at a horizon of more than a year.’
Here’s the impact on net exports:
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Doesn’t look good, does it? Most of the impact comes after that first year. So we’re only just getting into the business end of the impact of the dollar’s strength on the US economy. And the Fed are about to hike?
Check out his conclusion:
“To wrap up, while the dollar’s appreciation and foreign weakness have been a sizable shock, the U.S. economy appears to be weathering them reasonably well, notwithstanding their large effects on certain sectors of the economy heavily exposed to international trade. Monetary policy has played a key role in achieving these outcomes through deferring liftoff relative to what was expected a little over a year ago”
So his argument now is that they’ve been dovish enough because they have already postponed their first hike, even as now it’s just around the corner. This is insane monetary policy. They’ll tell you about the easing after it’s happened!!
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So who gets hurt the most?
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As Deutsche Bank details,
A stronger dollar, the reset in oil prices to significantly lower levels and slower global growth and investment spending vs. last cycle will challenge many of the S&P’s commodity and industrial capital goods producers for a long time. We’ve been under-weight Energy, Materials and Industrials since last year on these reasons and expect these sectors to underperform in 2015, 2016 and perhaps longer. Unless lower stock prices offer a more attractive entry point.
We remain concerned about the risk to EPS growth at many S&P industries with high foreign profits owing to FX translation from a stronger dollar. This includes most Technology, Industrials, Consumer Staples, and many Health Care and Consumer Discretionary stocks. Until we can observe how the dollar reacts to initial Fed hikes this remains a difficult risk to dismiss or quantify. At current FX rates, FX drags should stop in 2Q16. We see Industrials with most FX risk given its high foreign profits and then disadvantages vs. trade partners.
But CEOs are not ignoring this reality, as we noted previously, [15] "It's not the economy... it's the dollar" - That would appear to be the message from the companies of the S&P 500 who have reported in Q3. As FactSet reports, 18 of the 23 companies reporting so far have cited "the strong dollar" as having a negative impact on earnings. Not record domestic inventories (liquidation beginning) [16], the plunge in world trade [17], not the economic collapse in take your pick of Brazil (depression) [18], China (credit endgame) [19], India (exports/imports crash) [20], and so on...
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What is being missed here is that "The Dollar" is the symptom, not the cause of the problems. Capital is flowing for a reason to drive the USD stronger (or printed for a reason)... because the underlying economies are collapsing (yes and interest rate arb hopes).
So if ever there was a reason for The Fed to NOT raise rates, the pressure from Corporate CEOs (through their various lobbying or newsletter-writing alumni) must be immense...
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It appears, for now, financial engineering (buybacks) has kept the dream alive relative to the soaring USD vs Asian/EM countries (US growth opps); and "hopeful" projections have kept Forward estimates of earnings alive - even as The USD soars against the American companies' most favored growth nations...
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But at some point it's inevitable - unless there is a seismic shift in Fed Policy (QE4?) - that the USD's strength vs Asian/EM nations will crush earnings... and estimates will be unable to rise with even the biggest hockey-stick forecast.
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Remember. crises often start slowly... then erupt suddenly; and equity markets are always (without exception) the last to figure it out [23].
The credit cycle has well and truly rolled over...
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Charts: Bloomberg
