American businesses had become accustomed to a powerful dollar – for better or for worse. The strength of the US currency reached its apogee in late 2022, after a roughly 30% appreciation over six major peers in the prior decade (see chart below).
The dollar has retreated from this peak, but as recently as May a range of top US multinationals – including Apple and Procter & Gamble – were warning investors that the potency of the greenback was proving a drag on earnings, weighing on the domestic value of revenue earned overseas.
The DXY dollar index has fallen around 5% since its recent peak in late June
In recent months, however, there are signs that the muscle-bound US currency might be suffering from fatigue. The DXY dollar index has fallen around 5% since its recent peak in late June, losing ground against the euro, Japanese yen, British pound, Canadian dollar, Swiss franc and Swedish krona.
The move raises several key questions for finance professionals at US companies with exposure to international markets. Is the dollar’s fall likely to continue? And, if so, what does this mean for business?
Trending lower
On the first question, predicting moves in foreign exchange markets is far from simple. Currencies can be swayed by a bewildering range of forces, including central bank policy, economic growth, inflation, political shifts, patterns of trade, commodity prices and international mergers and acquisitions – to name but a few. With that caveat in mind, there are several key reasons to suspect that the dollar might continue to trend lower in the coming year.
A key source of the dollar’s potency in recent years has been US interest rates. The Federal Reserve kept rates at the highest level of all leading nations – reflecting the strength of the US economy. Now this period of US exceptionalism appears to be coming to an end. On 18 September, the Fed cut rates by 50 basis points – a larger single step than taken by peers such as the European Central Bank, Swiss National Bank or Bank of England.
For many of America’s top multinationals, a sigh of relief is in order
And despite starting late, the Fed now looks set to make up for lost ground. The median forecast from the Fed’s top officials is for 1.5 percentage points of rate reductions by the end of 2025. If this proves accurate, most economists believe this will narrow the generous interest rate premium offered by the US dollar over other leading currencies – reducing the greenback’s appeal for investors. UBS, for example, is expecting the dollar to lose further ground against its major peers.
What this means for US companies, and their top financial officers, is a matter of perspective. For many of America’s top multinationals, a sigh of relief is in order. A broad rule of thumb is that such firms tend to derive a larger share of their revenue from overseas. America’s largest publicly traded companies, represented by the Russell 1000, get close to 40% of their revenue from overseas. (That falls to just 20% for the Russell 2000, which includes more small-cap companies.)
Transaction benefit
As the dollar falls, such companies benefit from a ‘translation effect’ as foreign revenues are reported in the depreciated home currency. Those who export from a US base can potentially gain from a ‘transaction effect’, allowing them to lower the price of the goods and services they offer in foreign markets, or to fatten profit margins. As result, Bank of America has calculated that a 10% move in the dollar typically results in a roughly 3% swing in profits for S&P 500 companies.
The pressure on margins from pricier imports can spur executives to seek other efficiencies
But while many of America’s giants stand to gain from a moderation in dollar strength, a weaker currency is likely to be a headwind for some younger and smaller firms. Such firms typically have more foreign costs than revenue. In fact, less than 1% of the US’s 33 million small businesses sell their products to foreign buyers, according to the US Census Bureau. Yet many will be vulnerable to the rising cost of imported goods if the depreciation of the dollar persists and extends further.
Range of strategies
Finance chiefs facing such pressures can consider a range of strategies to cushion the pressure. Currency hedging through forward contracts or other derivatives can take the sting out of rising import costs and reduce uncertainty, though this can be costly. Such instruments usually only provide limited breathing room for companies to adapt, since the maximum duration of a forward contract available for businesses is usually 24 months. For the longer term, financial managers can also aim to identify domestic supplies. In addition, the pressure on margins from pricier imports can spur executives to seek other efficiencies to compensate for the drag.
The US economy is less vulnerable to currency swings than most nations
Not all is gloom, however. While some import-reliant companies could face a drag, the downside should be manageable for most. America’s broader economic environment looks positive. Smaller companies tend to benefit more quickly from rate cuts than larger peers. Nearly half of the debt held by Russell 2000 companies is floating rate, compared with roughly a tenth for the top tier of listed companies – who are more able to issue longer-duration bonds.
In addition, as Fed chair Jerome Powell stressed after the central bank’s September policy meeting, ‘the US economy is in good shape’, with American consumers still feeling confident. Against this backdrop, many companies facing higher import costs may be able to pass at least part of any increase to their customers. Finally, overall, the US economy is less vulnerable to currency swings than most nations, with foreign trade accounting for around 23% of GDP versus a global average of 52%, based on World Bank data. For comparison, the UK’s top 100 companies generate as much as 80% of their revenue outside the country.
Finally, it is worth noting that the dollar looks likely to weaken – not slump. For most financial officers at import-oriented firms, this should be an inconvenience rather than a disaster.
