Since the end of June, the trade weighted dollar index has moved steadily higher, with several catalysts responsible for its dramatic move. The usual geopolitical suspects include renewed Russian activity in the eastern Ukraine and the increasing threat from the Islamic State of Iraq and the Levant (ISIL). On the economic front, recent European Central Bank actions on reducing interest rates and weakening the euro have also created an incentive for money to move, as the central bank tries to deliver a modicum of inflation to the currency bloc. Finally, the threatened dissolution of the 307-year union between Scotland and England, has added to international investors worries, increasing demand for a safe haven currency.
Examining the price action of the dollar during this period makes one wonder if the rise in the currency in July foreshadowed the surprises recorded in August. Comments from the Federal Reserve Chairman Janet Yellen did little to clarify central bank policy during the annual Jackson Hole Symposium, meaning we still don’t know when interest rates may rise in the US. Interest rate differentials and, by extension, the growth rates they imply will likely be the most enduring driver and sustaining influence of the dollar’s rise.
Continued dollar strength will eventually exert a downward pressure on the profits of US multinational corporations as the value of foreign earnings are translated back into the “home currency” at less favourable exchange rates. This is important, since, if the past is anything to go by, investors tend to look through currency translations and focus on the operating performance of the businesses generating the earnings. The rise in the dollar began at the start of July, therefore investors should prepare themselves for the inevitable impact on third quarter profits and the headlines it will create.