The Super Dollar

With the US Fed on an anti-inflation tear, the recent surge in the world’s foremost currency is leaving few companies unaffected.

Software firm Salesforce expects to take a $600 million hit to revenues this year. Rival firm Microsoft expects the blow to be about $450 million. It’s not the war in Ukraine or high oil prices that’s causing the pain. The prolonged rise of the US dollar is having a dramatic impact on revenues of multinationals with strong overseas sales.

Even firms that don’t use the dollar are hurting indirectly.

“While we had a great quarter, the US dollar had a far better quarter than we did,” Salesforce CEO Marc Benioff told business TV channel CNBC. “I’ve never seen the strength of the dollar like this.”

The US Dollar Index, which tracks the greenback against a basket of major currencies, reached 108.5 in July, up 12.8% since the beginning of the year, the largest rise in two decades. The rise of the dollar sent other currencies, such as the British pound, the euro and Japanese yen, tumbling.

The strong dollar will have chopped $40 billion off the earnings of North American companies in the first half of the year, according to a projection by Wolfgang Koester, chief evangelist at currency firm Kyriba. 

While having a cheaper currency compared to the dollar should theoretically help companies in Europe and Asia price their products more competitively and earn higher profits, the fact that many commodity inputs in manufacturing are priced in dollars—consider iron, copper and oil—means the benefits to the weaker currency are small, and many are also taking a hit.

“Imports are getting more expensive in Europe and companies are suffering more,” says William De Vijlder, the Paris-based group chief economist of European bank BNP Paribas. “Increased export competiveness is a relatively small benefit compared to the higher import costs.”

While the war in Ukraine has encouraged some investors to move their money into US government debt as a safe haven, the primary driving force behind the dollar’s steep ascent is the differential in interest rates following the Federal Reserve’s efforts to contain the worst US price inflation in 41 years. The Fed on June 15 raised the benchmark fed funds rate by 75 basis points, the biggest increase since 1994, to a range of 1.5-1.75%—and promised more to come.

While the European Central Bank said it also would raise interest rates, by 50 basis points in July, its borrowing rate will still be negative, at -0.25%—a huge difference with the US rate. The euro has declined 11.5% from $1.13 since the beginning of the year, reaching dollar parity on July 13—the first time in more than two decades—after US inflation data spooked markets and led analysts to believe the Fed would be even more aggressive with rate hikes. 

Wells Fargo strategist Erik Nelson says in a note to clients that in addition to the monetary policy divergence, soft spots are emerging in the European economy so that EU companies are growing at a slower pace than US firms. “US underlying economic growth is materially stronger than that of the eurozone,” Nelson says.

Another explanation is that nervous investors are piling into dollars because dollar-based assets still have better returns despite swooning stock and bond markets. “The dollar has assumed the role of global stagflation hedge, with dollar cash being one of the few financial assets offering returns,” Deutsche Bank global currency strategist George Saravelos writes in a note to clients. “European investors are telling us they are selling down their overweight US bond and equity positions. But instead of repatriating the cash, they are hoarding it in dollars.”

While the rise of the dollar has not been as dramatic as it was in previous episodes of higher rates, it has been very long lasting, having begun the current strengthening phase in 2014. “In terms of persistence it may be historic, because some of the earlier ones were reversed,” says Joseph Gagnon, an economist at the Peterson Institute for International Economics. “The spikes in 1985 and 2000 were each reversed a couple of years later.  This rise of the dollar hasn’t been reversed.”

Many major British and European corporate entities, such as pharma giant GSK (formerly GlaxoSmithKline) and German software company SAP, already report their earnings in “constant” currencies, meaning they have taken out previous hedges so the change in dollar value has little short-term effect. “We have a kind of rolling hedging policy where we try to dampen the effects of the volatility in the US dollar-euro exchange rate by forward selling the future revenue,” said Airbus CFO Dominik Asam on a May 4 conference call with analysts. “If [euro] rates sustain at such a strong dollar rate, we would be able to hedge in more attractive rates and that is potentially a good offset to some of the downsides we are facing on the inflation side.”

Stuart Gregory, finance director of C. Brandauer, a precision metal stamping firm in Birmingham, England, says the strong dollar and weaker pound have been a boon for his firm’s business, which is about 50% exported outside the UK. “A lot of our materials are bought from Europe,” he explains, “so we’re not doing too badly, because the euro is quite healthy against the pound.”

Beyond short-term support to the bottom line, the differential shows potential to reshape some trade. “We do have US customers, and the strong dollar is obviously encouraging them to buy a bit more from us,” Gregory adds. “Not only buy a bit more, but also look at transferring some of their business away from the US.”

As the Feds move to raise rates touched off a global scramble by other central banks, even Switzerland felt compelled to join in, raising interest rates on June 16 by half a percent, also to -0.25, as inflation took hold in the country. The Swiss franc is down by 5.5% against the dollar this year, even after the rate hike by the Swiss National Bank, the first since 2007.

Jeffrey Frankel, a Harvard professor who specializes in capital formation and growth, noted in a recent column that a world accustomed to currency-depreciation wars is now instead seeing a currency-appreciation war, as each central bank tries to stay ahead of inflationary pressures on domestic prices by raising interest rates.

“With high global inflation likely to persist for some time, the prospect of reverse currency wars is looming larger,” Frankel comments. “Instead of a race to the bottom in the foreign exchange market, we may see a scramble to the top—and poorer countries are likely to suffer the most.”

It’s not just the dollar that C-suite executives are worried about, either. Oil prices, bottlenecks in supply chains and labor shortages all add to their woes. According to a global survey of corporate executives by the Conference Board, 15% of respondents say they think a recession is already underway and another 61% expect a recession in their primary region of operations before the end of 2023.

For corporate CFOs, the central bank actions created headaches beyond currency wars: The average interest rate on newly issued investment grade corporate bonds has risen from 2.49% at the end of 2021 to 4.42% in June 2022, while average rates for high-yield debt shot up from 5.64% to 7.53%, according to Leveraged Commentary & Data, part of data firm PitchBook.

Austrian utility EVN, for example, is marketing its second bond of the year at 105 to 120 basis points over swap rates, up from the 70 basis points it had to pay just two months ago. For European junk bond issuers, who saw a record low interest rate of 1.88% in August 2021, they must pay between 5.57% and 9.18%, according to Bloomberg data.

Higher corporate borrowing rates are likely to slow capital expenditures for such things as new factories and equipment, and the higher rates may force some overleveraged companies into insolvency. Cosmetics icon Revlon, for example, which has $3.7 billion in outstanding debts, filed for Chapter 11 bankruptcy on June 15.

Among industrialized countries, the most dramatic effect of the strong dollar is being felt in Japan. The yen tumbled below 139 to the dollar July 14, its lowest level in 24 years, after the central bank said it would not raise rates because inflation is much lower in Japan than in other nations. “It is not appropriate to tighten monetary policy at this point,” says central bank governor Haruhiko Kuroda. “If we raise interest rates, the economy will move in a negative direction.”

Japan’s main share index, the TOPIX, is heavily weighted toward manufacturing, thus “on balance, they are benefiting from [the weaker yen],” says Nicholas Smith, a strategist at broker CLSA in Tokyo. “Japan is brutally competitive at the moment.”

At Japanese pharmaceutical giant Takeda, for example, CFO Constantine Saroukos told analysts May 11 that the company’s revenue estimates were based on the yen being at 119 to the dollar. “If foreign exchange rates remain as they were at the end of April for the duration of fiscal year 2022, that would represent a high single-digit upside to our forecast for both revenue and core earnings per share,” Saroukos said. At the end of April, the yen reached 130 to the dollar.

CLSA’s Smith believes it was the slowing of the global economy rather than yen weakness that inspired concern about the outlook for Japanese corporates. Toyota, the world’s largest carmaker, said it expected net profit to fall from $22 billion in 2021 to $17.3 billion in the current year, despite the more favorable exchange rate and growing demand for small cars because of high gasoline prices. The company has long manufactured cars in the United States, where costs are based in dollars, largely because of a 25% tariff on imported SUVs.

However, despite the lower yen, Japan ran a $17.8 billion trade deficit in May because of the high cost of imported oil. The country has been forced to generate electricity with oil since the temporary closure of nuclear power stations following the Fukushima nuclear accident in March 2011.

 Other Asian countries are also benefitting from increased revenues in local currencies thanks to the strong dollar. “Manufactured exports have held up very well,” says Bob Fox, chair of the Digital Economy and ICT Group at the Joint Foreign Chambers of Commerce in Thailand. “The weak Thai baht against the dollar is one of the main reasons.” Fox says that companies that use local labor and don’t require imported commodities are doing extremely well even in the face of headwinds such as a tripling in shipping costs in dollars. These, he says, are usually passed on to the customer.

China, which carefully controls the exchange rate of the renminbi to the dollar, has allowed its currency to depreciate from 6.3 at the start of the year to 6.74, a decline of about 6.5%. The Chinese economy has been beset by Covid-19 lockdowns and the slowing global economy. Nonetheless, Chinese companies managed to export $52 billion to the US in May, compared with only $39 billion in February.

While investment dollars have flowed out of China this year, the Institute of International Finance reported that, in May, China recorded $2 billion of net inflows compared with $3.5 billion of outflows in other emerging market countries. 

A grim example is Sri Lanka, where the high, dollar-based cost of oil has plunged the country into the worst economic crisis in its history, with lengthy daily power cuts and a shortage of foreign exchange. The country is on the verge of defaulting on its foreign debts, many of which are priced in dollars.

“Today, the most likely victims of a strengthening dollar are not other major rich countries, but rather emerging and developing economies,” says Harvard’s Frankel. “Many of them have substantial dollar-denominated debts, exacerbated by the fiscal spending required to fight the Covid-19 pandemic. When the dollar appreciates, their debt-servicing costs increase in local-currency terms. The combination of rising global interest rates and a stronger dollar can trigger debt crises, as it did in Mexico in 1982 and 1994.”