At a Glance
- Investors are buying U.S. dollars because unlike other countries, growth in the U.S. is strong
Trade wars and any steps to block free market activity are supposed to be bad for a currency. But, instead of falling, the U.S. dollar is at its strongest level in 13 months. Since the beginning of the year, the dollar appreciated by more than 5% against the euro and British pound and over 7% against the Australian and New Zealand dollars. So, while many experts fear that a trade war would be damaging to the U.S. economy and its currency, so far, it has only made the greenback more attractive.
Here are 3 reasons why the dollar has been doing well and why it could continue to rise –
1) US Economy Is Doing Well
Investors are buying U.S. dollars because unlike other countries, growth in the U.S. is strong. The Dow Jones Industrial Average is near 6-month highs and last week, it rose 400 points in one day – the true signs of a bull rally. The labor market is healthy, the NASDAQ hit record highs and 2018 could prove to be the strongest year of growth for the economy in more than a decade.
Policymakers and economists are worried about potential fallout, but if you look closely, so far there hasn’t been much destruction. Instead, the strong performance of the U.S. economy allowed the Federal Reserve to raise interest rates twice this year and they will raise interest rates by at least 25bp and possibly even 50bp by the end of the year.
Most importantly, the Fed is one of the only major central banks tightening monetary policy more than once this year and until that changes, the dollar remains the best bet. If we look around the world, the Bank of England raised interest rates once in 2018 and won’t do it again before Brexit. The European Central Bank isn’t even thinking about a rate hike until the summer of 2019. The Reserve Bank of New Zealand just pushed out their forecast for a hike to 2020 from 2019, and the Reserve Bank of Australia said they see no reason to increase or decrease rates at this time. In contrast, the market appreciates the Fed’s slow and steady hand.
2) Investors are Worried About the Economic Impact of Tariffs
At the same time, there’s plenty of reasons to be concerned about what’s happening abroad. We should be worried about the economic impact of U.S. tariffs on the European Union, Canada, Mexico and China. On June 1, 2018, these nations were hit with 25% tariffs on steel and 10% tariffs on aluminum. In response, they announced retaliatory tariffs. While these tariffs represent only a small percentage of their GDPs, they’ve hurt business confidence and delayed investments, which could have a broader impact on the economy. There could even be more tariffs, which won’t be good for currencies and this explains why investors continue to take money out of the euro, Canadian dollar and Mexican Peso.
3) The Consequences of a Strong Dollar
Finally, the rising dollar is weighing heavily on other nations, especially those with floating currencies and significant dollar denominated debt. As the value of the dollar rises, it makes it more costly for those countries to service their debt. It also drives up the level of inflation and drives down the price of commodities, which is challenging for emerging market nations reliant on commodity exports. While major currencies are down only a few percent, the Argentinian peso is down 37% year to date, and the South African rand is down 14%. Other emerging market nations could fall victim to the same troubles.