Dollar’s stubborn strength dents US companies’ earnings cheer
A host
of U.S. companies are faced with a problem they had not expected to confront
this year: a rising dollar. Many market participants believed the dollar would
fall on the back of interest rate cuts that both investors and the Federal
Reserve had pencilled in for 2024. Those cuts are yet to come, and the U.S.
dollar index (.DXY), opens new tab, which measures the greenback’s strength
against a basket of currencies, is up 4% in 2024 and has climbed about 16% in
the last three years.
While
those gains reflect the
relative strength of the U.S. economy, a
rising dollar can be a problem for some companies. A strong U.S. currency makes
it more expensive for multinational companies to convert foreign profits into
dollars, while also hurting the competitiveness of exporters’ products.
Companies guarding against dollar strength must also devote resources to
hedging strategies that offset the effects of the rising currency on their
bottom lines. All told, every 10% year over year rise in the dollar shaves some
3% from S&P 500 earnings, according to estimates from BofA Global Research.
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The
dollar’s strength in the latest quarter comes during a period of robust
corporate profits. With well over 80% of the
S&P 500 having reported first quarter results, companies are on track to
have increased earnings by 7.8%, up from an expectation of 5.1% growth in
April, according to LSEG IBES. Nonetheless, companies from Apple Inc (AAPL.O),
opens new tab and IBM (IBM.N), opens new tab to Procter & Gamble(PG.N),
opens new tab have mentioned foreign exchange as a headwind.
The
strong dollar “has caused a lot of consternation,” said Andrew Gage,
senior vice president at treasury and finance solutions firm Kyriba. “CFOs
are asking their treasury teams to be much more diligent in managing the risk
that comes from that strong dollar.” The dollar’s gains are being fueled
by U.S. economic strength, which is eroding expectations for how deeply the Fed
will be able to cut rates this year. Investors are pricing in around 50 basis
points of rate cuts for 2024, compared to more than 150 basis points forecast
at the beginning of the year, futures markets show. Yields in the U.S. stand
above those in many other economies as a result, bolstering the dollar’s appeal
over other currencies.
“Nearly
all FX practitioners were expecting the dollar to be weaker this year with the
anticipation of lower U.S. interest rates,” said Amo Sahota, director at
foreign exchange risk management firm Klarity FX in San Francisco.
“Corporates were licking their lips, essentially waiting for that to play
through.” Not all S&P 500 companies are equally affected by the
dollar’s swings. The information technology, materials and communication
services sectors top the list with the most international revenue exposure,
garnering as much as 57%, 52% and 48% of their total revenue respectively from
abroad, data from FactSet showed.
To
prevent exchange rate moves creating big swings in earnings, businesses use
various hedging strategies including those that employ forward and options contracts.
Some firms that advise companies on managing FX risk noted a rise in hedging
activity in recent weeks, though quieter currency markets have made hedging a
less urgent issue for some companies even as the dollar has risen. In March,
Deutsche Bank’s index of currency volatility (.DBCVIX), opens new tab fell to
its lowest level since September 2021.
“Towards
the end of the first quarter, we did see some complacency on the hedging front.
Currency volatility fell to a multi-year low, which led to a lack of a sense of
urgency,” said John Doyle, head of trading and dealing at Monex USA in
Washington. “However, we have seen a recent uptick in hedging over the
past month and a half.” Karl Schamotta, chief market strategist at
payments company Corpay, said the subdued level of currency volatility may be
making some companies “almost too complacent about the risks they are
facing.”
