Who’s Afraid of the Rising Dollar? Not the Thriving U.S. EconomyShobhana Chandra and Christopher Condon
Don’t believe everything you hear about the corrosive effect a more expensive dollar has on corporate America. U.S. businesses and the world’s largest economy can handle the greenback’s strength just fine.
Companies in the Standard & Poor’s 500 Index, from drugmaker Pfizer Inc. to Microsoft Corp., Procter & Gamble Co. and Royal Caribbean Cruises Ltd. have blamed the strongest dollar in more than a decade for crimping profits in 2014, or indicated it will hurt them this year.
The bigger picture is hardly so dire. Viewed as a whole, American business is much less vulnerable to the dollar’s rise than are the U.S.-based multinational giants. The exchange rate poses an even smaller threat to U.S. economic growth, which wrapped up its best year since 2010. While a strong dollar may weaken exports, it also means cheaper oil, less costly goods from overseas and continued low inflation -- all good things for an economy that’s powered by consumer spending.
“There’s going to be some pain for large corporations, but broadly speaking, the increase in the dollar is something the U.S. economy is able to absorb,” said Michelle Meyer, senior U.S. economist at Bank of America Corp. in New York.
The U.S. currency gained against all 31 of its major peers last year. For American companies, that means earnings denominated in euros, Swedish kronor or Brazilian reals will purchase fewer dollars. From its mid-2014 level to early January, the broad trade-weighted dollar jumped 10 percent, its fastest six-month gain since the 2008 financial crisis, catching some companies unprepared.
Bank of America estimates a sustained 10 percent rise in the greenback trims about 3 percent off annual per-share earnings for the S&P 500 group.
The big multinationals are among companies with the most at stake. Overseas sales account for about 50 percent of the combined revenue for the 30 companies represented in the Dow Jones Industrial Average, according to Howard Silverblatt, senior index analyst at S&P.
Most U.S. businesses aren’t nearly so reliant on markets abroad. For members of the S&P Midcap 400 Index, foreign sales make up 23 percent of revenue, Silverblatt calculates. The figure drops to 16 percent for the S&P Smallcap 600 Index.
From the perspective of the $17.7 trillion U.S. economy, the exchange-rate impact shrinks to barely a blip. Bank of America reckons a 10 percent jump in the dollar after inflation would shave only 0.25 percent from economic growth a year later. Growth may accelerate to a 3.2 percent pace this year from 2.4 percent in 2014, according to the median estimate in a Bloomberg survey in January.
It’s true the trade deficit may widen as exports become less attractive to overseas buyers. Imports turn cheaper and may grow, which “diverts some demand away from domestic producers to foreign producers,” said Kevin Logan, chief U.S. economist at HSBC Securities USA Inc. in New York.
On the other hand, the price of imported manufactured goods will fall, holding down inflation and lifting Americans’ purchasing power, he said. That’s the more important effect, because consumer spending is almost 70 percent of gross domestic product, while exports account for just 13 percent.
Even companies with the highest levels of foreign receipts find ways to minimize their exchange-rate risk. One is by moving production to markets where they get their sales.
“Most of my companies have been on a 20-year concerted effort to regionalize their supply chains to match that with their customers,” said Steven Winoker, a Sanford C. Bernstein & Co. analyst in New York who tracks companies from Honeywell International Inc. in Morris Township, New Jersey, to Danaher Corp. in Washington.
That means when a strengthening dollar reduces the relative value of overseas revenue, much of the cost of producing that revenue -- including labor, utilities and materials -- decreases by the same proportion.
“The U.S. corporate strategy abroad is based on direct investment, not exporting,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co. in New York. “You supply overseas demand with foreign factories. The best thing for U.S. companies is not a weaker dollar, but stronger world growth.”
When the greenback gets more expensive, companies are under no obligation to exchange the profits they earn in other currencies into dollars and send them home. They can reinvest in the same foreign markets or just keep cash parked abroad, something many do anyway to avoid U.S. taxes. President Barack Obama’s budget estimates U.S. companies have stockpiled about $2 trillion of earnings outside the country.
And when corporations do make currency transactions, much of that exchange-rate risk can be managed through hedging. Fairfield, Connecticut-based General Electric Co. uses currency futures contracts to protect earnings.
GE estimates the dollar’s appreciation shaved fourth-quarter earnings by about 2 cents, to 52 cents a share.
“We hedge all of our transaction exposure to the extent we can,” Chief Financial Officer Jeffrey Bornstein said in a conference call with analysts Jan. 23. “We’re not at a point yet where we think it’s something that’s not manageable across our portfolio.”
Apple Inc. has already carried out its most aggressive steps in years to blunt the effects of currency swings on revenue, not only by hedging but also by raising prices for iPhones in Russia to counter the ruble’s plunge and charging more for mobile software applications from Canada to Europe.
That helps explain why Cupertino, California-based Apple expects “a strong March quarter” with revenue gains of 14 to 20 percent “in spite of the fact that you’ve heard from many U.S. companies these days that foreign exchange has become a challenge,” Chief Financial Officer Luca Maestri said in an interview on Jan. 27.
Even with the recent surge, the dollar is only coming off historical lows. The U.S. Dollar Index spot rate of 95 on Wednesday was still lower than in 1985, when it exceeded 160, or even the 2001 level that topped 120. The Intercontinental Exchange Inc. uses the index to track the greenback against currencies of six trade partners.
This time, companies have been quick to bemoan the currency surge in large part because it coincides with cooling markets from Europe and China to Russia and Latin America, said Nariman Behravesh, chief economist for IHS Inc. in Lexington, Massachusetts, and among the top forecasters of the economy over the last two years according to data compiled by Bloomberg.
That slowdown “is a much bigger deal than the exchange rate,” he said.
Companies whose earnings are under pressure acknowledge the dollar is only one of several headwinds.
Apparel maker Ralph Lauren Corp. trimmed revenue growth projections for this year, and Chief Operating Officer Jacki Nemerov, commenting on a Feb. 4 earnings call, blamed “geopolitical tensions” as well as the dollar’s strength.
The U.S. is well positioned to cope, said Behravesh, who called the currency’s advance “a very strong positive for the U.S.” It is helping push long-term Treasury yields to record lows as overseas investors flock in to profit from dollar assets amid bets the Federal Reserve may raise its main interest rate from near zero by mid-2015.
“If it has to happen, this is actually the best time” for the greenback’s climb, said Behravesh, adding the rise in 2015 is unlikely to match last year’s.
Scott Brown, chief economist at Raymond James & Associates Inc., said the positive outlook for investment and hiring in the U.S. stays intact, because “the run-up in the dollar has been beneficial to the overall economy. That matters more than the hit to company earnings.”
“We’re hearing all these cautionary statements,” St. Petersburg, Florida-based Brown said. “But then you turn back and look at the U.S. economy, where demand is getting better all the time,” and the conclusion is, “we can get over it.”