Start Watching the US Dollar

Asset prices have experienced a significant rally in the past few months, but there hasn't been a narrative. Despite ongoing economic challenges and uncertainties, various markets, such as stocks, bonds, and crypto, have significantly increased prices. Some attribute the rally to increased investor optimism and newfound confidence in the future, while others point to the impact of unprecedented monetary and fiscal stimulus measures. I say a weak dollar has fueled this rally, but this will be changing in recent months.

From a chart perspective, $DXY has found a local bottom. $DXY refers to the US Dollar Index, which measures the value of the US dollar relative to a basket of six major foreign currencies, including the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc. It is used as a benchmark to track the performance of the US dollar against these currencies and is widely followed by market participants. Why does dollar strength matter?

The strength of the US dollar affects traders in several ways. If the dollar is strong, it has a higher value than other currencies, making exports cheaper for foreign countries and imports pricier for domestic consumers. This can impact the trading of goods and services and the profits of international companies. Additionally, a strong dollar can impact the prices of commodities, such as oil, which are often traded in dollars and can impact the performance of foreign investments.

The strong US dollar has significant implications for inflation pressures around the world. A strong dollar means that the dollar's value relative to other currencies has increased, which can influence prices in other countries. When a country's currency weakens against the US dollar, imports from the United States become pricier. This can result in upward pressure on prices in the importing country, as firms may choose to pass on the increased costs of imports to consumers. The impact of a strong dollar on inflation in other countries can be substantial, with studies showing that, on average, a 10 percent appreciation of the dollar leads to a 1 percent increase in inflation abroad.

For countries that heavily rely on imports from the United States, such as raw materials or consumer goods, a strong dollar can significantly impact inflation. In these cases, the higher import prices can ripple through the domestic economy, leading to higher costs for businesses and households. This, in turn, can result in higher prices for a wide range of goods and services, contributing to inflation pressures.

In the context of record inflation and quantitative tightening, the strong dollar only exacerbates the ongoing contraction in multinational corporations' top and bottom lines. A significant portion of companies' revenue in the S&P 500 index is derived from international operations, with an estimated 40% of revenue coming from overseas. This is particularly true for the tech sector, where the global revenue share is estimated to be greater than 50%.

A strong dollar makes exports from the United States pricier, reducing demand and potentially affecting the profits of multinational corporations. In addition, the rise in inflation and the tightening of monetary policy, which is reflected in rising interest rates, can also put pressure on the bottom lines of corporations, as higher costs for borrowing and higher prices for goods and services can reduce profits.

A stronger U.S. dollar has the potential to impact both domestic and international economies in several ways. On the one hand, strengthening the dollar has slowed the inflation rate in the U.S., leading to lower costs for consumers. However, on the other hand, this same strong dollar also contributes to a rise in inflation rates in many other countries. This increase in inflation is making it pricier for individuals in these countries to purchase goods, leading to decreased purchasing power.

Additionally, the stronger U.S. dollar is affecting the global economy. Companies in the U.S. that do business overseas and rely on foreign revenue to fuel their profits are facing a significant reduction in income due to the strong dollar. This reduction in revenue can lead to a decrease in economic activity, weakening the global economy.

If we start seeing a stronger U.S. dollar, it will present a complex challenge for the U.S. and international economies. It could lead to another leg of inflation. This rally is built on optimism that a soft landing or no landing will crash and burn with a potentially hotter-than-expected inflation reading. The next CPI print and inflation metrics in the coming months will continue to tell us whether our digital assets are safe.