Following weeks of losses against a basket of major currencies, the US dollar picked up in the last week. The greenback’s value has been falling consistently, with speculation over the likelihood of interest rate hikes. However, with New York Federal Reserve President William Dudley saying that 2 interest rate hikes this year are a reasonable expectation, the dollar index gained significantly. From its low point at 92.626, the dollar index reached a high of 93.9.
The dollar index measures the USD against a basket of 6 major currencies, and was vulnerable on Friday in reaction to news that U.S. employers added 160,000 workers in April, the fewest in seven months. However, news of the expected hikes helped it recover and continue its advance.
While the impact of the dollar gain is directly proportional for currency traders, not all companies gain. Stocks have gained as a result of the dollar’s strength, but certain companies have made significant losses due to exchange rate volatility.
Let’s take a look at some of the stocks that have been rising as a result of the dollar’s increase.
The dollar index (USDX) value has a consistent positive correlation with the Dow Jones Industrial Average (DJIA), the Nasdaq and S&P 500. As the dollar index rises, so do these stock indexes. The USDX rises due to increased demand for the USD. This generally happens when investors put their money in US equities which, in order to purchase, requires them to first buy US dollars. This is the major reason that when the dollar rises, the stock indexes follow a similar trajectory.
However, this positive correlation is not definitive. Since stocks and currencies are influenced by a large number of factors, the correlation will never be all that high.
A brief look at the performance of these indexes over the past week as the dollar has risen shows:
- The DJIA rose 0.5%
- The Nasdaq rose 0.4%
- The S&E 500 rose 0.3%
As expected, these indexes rose in correlation with the USDX strength.
A range of IPOs also gained heavily. Activision Blizzard (ATVI) rose 8%, while Yelp jumped 24%.
The collateral damage
However, the strong dollar was not good news for all companies. International companies were hit by the change in exchange rate, with the more expensive dollar causing a shift in expectations. International companies lose out on profitability when foreign currencies are worth less. Expenses remain the same in dollar terms, but income is lower.
A strong dollar therefore forces international companies to raise prices in other currencies, losing some of their competitive edge.
These 3 companies are excellent examples of some of the big losers from the dollar’s strength:
- Johnson & Johnson: In the fourth quarter of last year, Johnson & Johnson saw a 2.4% drop in sales. The primary reason was the strength of the dollar. Nearly half of its revenue comes from outside the US, making the strength of the dollar a ubiquitous factor in its sales. J&J had cause for optimism, with the dollar weakening in April, but now that it is growing stronger again, expectations may continue to drop.
- Xerox Corp: Xerox gets a third of its revenue from outside the US, and the stronger the dollar, the weaker its performance. Xerox lost as much as 4.2% in quarterly revenue, causing its shares to fall over 13% in just one day’s trades.
- Whirlpool Corp: The world’s largest appliance maker saw its international status take a hit as the dollar strengthened over 2015. Net income in the first quarter of 2016 was only $150 million, down from $191 million at the same point in 2015. It has benefited greatly from the dollar’s recent dip, but as the currency once again surges, Whirlpool Corp will necessarily be nervous.
FX management in big corporations
The problem of changing currency rates will not go away – not for international companies at least. Mitigating the impact of changing US dollar exchanges has become a high priority, and FX management is now a focal point.
Smart FX management can help international companies mitigate their losses. FX management, for the uninitiated, refers to hedging one’s financial expectations against the changing rates. Some examples include:
- forward contracts: these contracts “lock” you into a specific exchange rate. Although this means you won’t benefit from the exchange rate moving in your favor, it allows you to make accurate calculations without worrying that a strong dollar will hit your company hard.
- limit orders: these orders tell your broker to buy or sell currency at a certain rate. Only at that rate will the order be executed. This way, you can choose the lowest acceptable exchange rate, mitigating the extent of your losses.
- participating forwards: these forward contracts provide protection at an agreed strike rate, without stopping you from potential growth from favorable exchange rates.
The dollar going forward
The next few months will be telling for the US dollar. Will it continue to strengthen or will it once again hit a downward trend? This is what might be in store for some of its most popular pairings:
USD/GBP: Analysts expect the dollar’s rise to continue against the pound sterling. Its rally is not a brief blip in a downward trend, but signifies a return to its strong gains. With Brexit looming, the USD looks like it will be a good bet in coming months.
USD/EUR: The USD/EUR pairing has been particularly interesting, with contradicting news over possible Fed rate hikes compounded by uncertainty in European economies. The future of the Greek economy in particular is making its mark on the Euro, and of course Brexit affects the USD/EUR price too. Analysts predict that the USD will continue to rise against the EUR in the short-term, but long-term predictions are anyone’s guess.
USD/JPY: With both Japan and the US on the verge of releasing important financial data, economists are wary of making any definite projections. While the USD has been making important gains against the JPY, this could change with rates decisions from the central banks of both countries.
FX management all the more important
The recent fluctuations in the dollar strength have served as a warning of how significantly companies can be hit by small changes. FX management is becoming all the more important.
While big corporations cannot rely solely on forward contracts and the like, the continuing search for a solution is likely to bring more attention to this area in the near future.
Image credit: CC by 401(K) 2012