The U.S. Dollar (ISO code USD) is the national currency of the United States and is referred to as “the world’s reserve currency.” It has been the dominant global currency for decades, but its dominance is in question. The dollar is often viewed as a proxy for investor confidence in the U.S. economy and the country’s role in the world’s financial system.
When the dollar is strong, it makes investments in other countries more expensive. In addition, companies with significant international revenue see their profits squeezed by the stronger dollar. For example, McDonald’s reported that changes in foreign-currency values sliced 3% off its summer revenue. Microsoft and other technology firms have warned that a weaker dollar could reduce their earnings.
As a result, investors are pulling money out of stocks and bonds in favor of safer investments like cash. The resulting flow of funds to the safety of bonds has contributed to a rout in stocks, with many analysts predicting that the stock market is entering a bear market.
Cooling U.S. inflation is helping to accelerate a decline in the dollar, which has fallen nearly 13% against a basket of currencies from last year’s two-decade high and now stands at its lowest level in 15 months. Its decline quickened after the U.S. reported softer-than-expected inflation data on Wednesday, supporting views that the Federal Reserve is nearing the end of its interest rate-hiking cycle.
A lower dollar makes it cheaper for foreigners to buy American goods and services, which may boost economic growth. However, a falling dollar also makes American exports less competitive globally, as the price of commodities is repriced in dollars.
The dollar’s strength reflects the markets’ view on the policies of the various governments and central banks. Fighting a brewing inflationary threat, the Fed has embarked on a steep path for interest rates. At the same time, the European Central Bank and central banks in Japan and China have held their policy rates relatively steady.
Fidelity’s Kana Norimoto, a fixed-income macro analyst, says the dollar’s strength is unlikely to be a significant factor in determining stock sector performance over the coming year. Norimoto points out that the strength or weakness of a dollar has historically been a much less reliable indicator of how specific sectors will perform, as it depends on global capital flows. Instead, she recommends that investors focus on the economic fundamentals of individual companies. For instance, a company with a significant presence in international markets should be able to handle a wide range of economic conditions.