The Dollar’s Strength Cuts Both Ways for Investors

December 9, 2014

by Michelle Perry Higgins

The strength of the dollar is a double-edged sword, and it remains to be seen which edge is the sharper. The strong dollar speaks not so much to the strength of the U.S. economy, but to the continuing weakness in much of the rest of the world, too.

 Our economy, while anemic by our standards, is still growing faster than Europe and much of the rest of the world with the notable exception of China. When global investors look at the state of world economies, the U.S. stands out not only because it has solid, if unspectacular, growth, but also because it has a stable political and legal system. Hand in glove with the relative economic strength of the U.S. is a significant interest-rate differential, as the U.S. prepares to possibly increase rates next year while other countries and the European Union announce their willingness to pursue more monetary easing. Rising interest rates encourage more investment for fixed-income investors and supports the dollar. A strong dollar has the positive effect of putting a lid on inflation in the U.S. and putting more money in the pockets of consumers as imports become cheaper. This is especially true of commodities like gold and oil that are traded globally, largely in dollars.

However, the strong dollar is indeed a double-edged sword. It makes U.S. goods and services more expensive in comparison to the offerings of competitors. It also has the effect of reducing the value of corporate profits from overseas operations. This makes for a more challenging environment for U.S. companies and may ultimately end up negatively affecting their profit margins. With the profit margins of U.S. companies in record territory supporting stock market valuations, the strong dollar may well impact a number of large U.S. companies that compete in world markets.