The U.S. dollar is on the skids. Down more than 10 percent against the euro, 6 percent against the Yen, and 4 percent against the British pound this year, the slumping dollar is having a real economic impact.
“Dollar weakness is the result of a few factors. One is the reduction in commodity prices, which reduces the demand for the dollar,” explains Gemma Wright-Casparius, senior portfolio manager of Treasuries at Vanguard. “The second is the fact that the market has priced out subsequent Fed rate hikes. We have had two this year and the market no longer sees hikes has a high probability for the remainder of 2017. The final factor, the market has become more realistic, or less optimistic, about the immediacy of fiscal policy stimulus to the economy.”
What does that really mean for investors?
First, it means the Fed’s hands are tied on monetary policy. The confluence of a strong stock market, stubbornly low long-term bond yields, and the weak dollar are causing the Fed to hit pause on raising rates. As a result, investments that were expected to benefit in a rising rate environment may not see that catalyst manifest.
Second, these low rates are reducing the dollar's appeal to foreign investors. Thus U.S. bonds are less attractive.
Finally, the weak dollar has not lead to higher prices, as it normally would, so inflationary pressure has not hit the U.S. consumer.
Understanding The Playbook
A weak dollar means U.S. made goods are cheaper to manufacture, making exported goods more profitable for U.S. domiciled companies. It also means U.S. companies can sell their goods for less, making them more competitive on the global front. Conversely, foreign or imported goods are more expensive to the American consumer.
Similarly, travelling to a foreign country is more expensive. The U.S. dollar is worth less, so it takes more dollars to buy foreign goods and services. However, travel and tourism to the U.S. is boosted as it is cheaper for foreigners to visit the U.S. and it is less expensive for Americans to stay at home.
Moreover, a weak dollar and low interest rates are less attractive for investors, who no longer want to invest in U.S. bonds or hold the currency outright.