One downside of the US having a relatively strong economy compared to the rest of the world is the strength of our currency. The dollar has been on a relatively strong run against most of the world's currencies, and is approaching a one-to-one value with the euro — something that has not happened in the past thirteen years. For 2015, the US Dollar Index (NYSE:DXY) that represents the greenback's value against a basket of major currencies increased approximately 10%.
Will the dollar cross the parity threshold again and achieve a greater value than the euro? There are several signs that suggest that it may do so.
- Economic Growth – While the US averaged an unspectacular 2% growth last year, the Eurozone is mired in an essentially flat economy. Eurozone growth averaged a miserable 0.4%, and the European Central Bank (ECB) embarked on a bond-buying stimulus similar to that of the Federal Reserve several years ago. Those combined steps will keep the euro relatively weak.
The economic slowdown in China has hurt the US, but it has taken a toll on the European economy as well, especially in relatively healthy Germany. It seems likely that for the near future the US economy will continue to plug along at a better rate than the Eurozone, keeping upward pressure on the value of the dollar.
- Interest Rate Hike –The long-awaited interest rate increase from the Federal Reserve has made the dollar even stronger as investors flock to dollars to hold US debt.
- Volatility – When stocks go through turbulent and volatile times, investors periodically flee stocks for safer assets — typically US Treasuries and greenbacks. Calling the dollar a safe haven is not really accurate, but it does tend to see higher activity and greater strength when world equities are volatile, as they have been in recent times.
Assuming that the dollar does cross that threshold, what does it mean? There is nothing magical about parity with the euro, but equivalence does mean that the current problems associated with a strong dollar will be aggravated.
Companies that are dependent on exports are harmed as their products become more expensive relative to foreign competitors. Multinational companies with a large international presence such as Coca-Cola (NYSE: KO), Procter & Gamble (NYSE: PG), and Caterpillar (NYSE: CAT) are also harmed by the strong dollar. US tourist sites that attract international visitors may suffer as well.
However, a strong dollar does have some positives. Raw materials from overseas are cheaper for US manufacturers, and industries depending on imports in general receive a boost. US tourists that travel to Europe will benefit from the relative strength of the US currency.
The strength of the dollar did not come as a surprise to analysts. Back in January 2015, Goldman Sachs predicted that the diverging directions of the US and European economies and fiscal policy would have the dollar equaling the euro by the end of 2016. As they predicted, the euro was worth just $1.08 by the end of 2015. As of this writing, it is $1.09. Goldman Sachs may or may not have the timing right, but their prediction of eventual parity looks reasonably accurate.