Love That Strong Dollar. It May Not Last

(Bloomberg Opinion) -- John Connally, the Nixon administration Treasury secretary, famously told a group of central bankers that the “the dollar may be our currency, but it’s your problem.” That’s as true as ever, with the strong buck causing a few headaches abroad — but generally leaving the US economy unscathed.

Current conditions find the Bloomberg Dollar Spot Index hovering close to the highest in five months, after posting large gains in recent months against most major currencies, including the South Korean won, the Japanese yen and the Swiss franc. That prompted South Korea Finance Minister Choi Sang-mok and his Japanese counterpart Shunichi Suzuki last week to express “serious concerns.” But unlike episodes past, the latest bout of dollar strength isn’t generally something to fear on a US or global level.

When the world gets scary or uncertain, investors tend to rush for the warm embrace of the buck, which sometimes makes its appreciation feel like a warning. For example, the dollar’s flight-to-safety credentials were on display in the early days of the Covid-19 pandemic and the 2016 Brexit vote. That hasn’t been the main story in the current episode, however, and to prove it, consider the currencies that the dollar has been appreciating against this year: . Several risk-on currencies such as the Mexican peso and Canadian dollar have done comparatively fine. 

In reality, today’s dollar strength is mostly a straightforward reflection of interest-rate differentials. With the Federal Reserve expected to keep policy rates high for longer than peers, market pricing finds 10-year US Treasury notes yielding several percentage points more than developed-market counterparts. Add to that the outperformance of the US stock market, and it’s clear that flows have stemmed primarily from bullish profit-seeking, rather than fearful cash-hoarding. You’d probably have to go back to the late 1990s to find another period when the dollar was reliably strong for the right reasons.

Is any of this bad for the US? On net, probably not. On the consumer price side, the dollar is keeping a lid on import prices and preventing inflation from getting out of control again. Multinational firms bringing home less revenue from abroad can take solace in knowing that their main market remains strong, with economists surveyed by Bloomberg expecting that the US economy grew 2.5% in the first quarter on an annualized basis.

Dollar gains have a meaningful negative impact on the competitiveness of “old economy” manufacturers in, for example, the paper products and autos industries, and could hamper the fantasy of returning America to its assembly-line glory days. But the negative effects are much more muted for advanced manufacturers in aerospace, pharmaceuticals, semiconductors and much of the modern consumer discretionary landscape — which all play prominent roles in the US stock market today. In fact, stocks of the latter three groups all tend to have a positive relationship with dollar strength holding all else equal, according to research from the economist Willem Thorbecke. As he posited in his paper, manufacturers of technologically advanced products may have greater market power that makes their businesses less sensitive to pricing. 

Of course, it’s always possible that this dollar rally will morph into something more insidious and risk-off in nature. Investors have gotten a taste of “bad dollar strength” amid rising Israel-Iran tensions, but that hasn’t been the main story for exchange rates. The buck’s strength has come at the expense of other developed-market economies — generally more so than emerging markets, although there are exceptions — which can handle the stress without triggering some sort of crisis. And, as my Bloomberg Opinion colleague Daniel Moss noted recently, we are far from the circumstances that brought on the Asian financial crisis: More flexible exchange rates today avert the risk of meltdowns, and central banks manage their reserves and rates policy more strategically.

The final reason to stay relaxed about the mighty buck is that it isn’t likely to last. It’s mostly a reflection of yield differentials, and I still hope and expect that they’ll start to narrow later in the year when Fed policymakers get the disinflation data they need to start reducing rates. 

The US is a titanic force in the global economy, accounting for about a quarter of world gross domestic product and around half of global equity market capitalization. In a sense, it’s the single most important variable for the global economy. The dollar may be a bit of a problem for some specific economies, as Nixon’s Treasury secretary observed, yet, in the grand scheme of things, it’s unlikely to become such a global headwind that it ultimately causes trouble back home.More From Bloomberg Opinion:

• King Dollar Risks Becoming Greenback the Bully: Marcus Ashworth
• Dollar on a Rampage Is a Test for Asian Currencies: Daniel Moss
• It's Time for Earnings to Prove the Bulls Right: Jonathan Levin

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jonathan Levin is a columnist focused on US markets and economics. Previously, he worked as a Bloomberg journalist in the US, Brazil and Mexico. He is a CFA charterholder.

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