WASHINGTON — The US dollar has risen so much that it is nearly equal in value to the euro for the first time in 20 years. This trend, however, threatens to hurt American companies as their products become more expensive for foreign buyers. If US exports were to weaken as a result, so would the already slowing US economy.
Yet there is also a silver lining for Americans: a stronger dollar provides modest relief from runaway inflation as the wide range of goods imported into the United States – from cars and computers to toys and medical equipment – become cheaper . A strengthened dollar also offers good deals for American tourists visiting Europe, from Amsterdam to Athens.
The U.S. dollar index, which measures the value of U.S. money against six major foreign currencies, has jumped nearly 12% this year to a two-decade high. The euro is now worth just under $1.02.
The dollar is rising primarily because the Federal Reserve is raising interest rates more aggressively than other countries’ central banks in its effort to quell the highest US inflation in four decades. Fed rate hikes drive US Treasury yields higher, attracting investors looking for higher yields than they can get elsewhere in the world. This increased demand for dollar-denominated securities, in turn, drives up the value of the dollar.
Also contributing to the currency’s appeal, notes Rubeela Farooqi of High Frequency Economics, is that despite concerns about a potential US recession, “the US economy is on stronger footing compared to the Europe”.
Not since July 15, 2002 has the euro been valued at less than one dollar. On that day, the euro broke above parity with the dollar as huge US trade deficits and accounting scandals on Wall Street sent the US currency plummeting.
This year, the euro has slumped largely on growing fears that the 19 countries that use the currency could slide into recession. The war in Ukraine has boosted oil and gas prices and punished European consumers and businesses.
In particular, the recent cut in natural gas supply from Russia has sent prices skyrocketing and raised fears of a blackout that could force governments to ration energy to industry to spare homes, schools and hospitals. (European leaders denounced Moscow’s move as an effort to blackmail Europe for backing Ukraine and enacting Western sanctions following the Russian invasion.)
Berenberg bank economists have calculated that at current consumption rates, the additional gas bill would be 220 billion euros ($224 billion) over 12 months, or 1.5% of annual economic output.
“This war is a ‘death blow’ to Europe,” Robin Brooks, chief economist at the Institute of International Finance Banking Trade Group, tweeted last week. “It undermines the German growth model which is based on cheap Russian energy. Europe is facing a seismic shift, and (the) euro needs to fall to reflect that.”
A European slowdown could potentially give the European Central Bank less leeway to raise rates and moderate economic growth to solve its own inflation problem. The ECB announced that it would raise its key rate by a quarter of a point at its meeting later this month and possibly up to half a point in September. A weaker euro fuels inflationary pressures by making imports to Europe more expensive.
UniCredit analysts said global recession fears were a key driver in currency markets “in the general view that the Fed may ultimately have more opportunity than many other central banks” to raise interest rates. rate. Analysts also noted the dollar’s role as a globally recognized safe haven, in light of recent financial market turmoil, as another factor driving demand for the dollar.
Meanwhile, the rising dollar is complicating the already uncertain outlook for the United States, the world’s largest economy. On the one hand, the appreciation of the greenback makes foreign goods cheaper for Americans and dampens inflationary pressures. But not by much.
Mark Zandi, chief economist at Moody’s Analytics, calculates that a 10% rise in the dollar over the past year, against the currencies of its trading partners, has reduced inflation by about 0.4 percentage points. percentage. Although Zandi calls this a “significant” effect, he notes that consumer prices have climbed 8.6% over the past year, the biggest year-over-year gain since 1981.
And a stronger currency weighs heavily on American companies doing business abroad. On the one hand, it erodes the profits of multinational companies that depend on overseas sales. The stronger dollar makes their foreign income less valuable when they convert it to dollars and bring it back to the United States. Microsoft, for example, last month lowered its April-June earnings outlook “due to an unfavorable movement in exchange rates.”
Worse still, a stronger dollar makes US-made products more expensive in foreign markets, while giving foreign products a price advantage in the United States.