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Strong dollar wipes billions of corporate America’s earnings

Corporations are facing myriad challengessupply chain snarls, the lingering effects of the pandemic, the Russia-Ukraine war, the global energy crisis, China’s economic slowdown, inflation, interest rate hikes, and now another growing threat – a strong US dollar.

This meteoric ascent of the dollar is taking a bite out of corporate earnings, particularly for US corporations doing business abroad or getting most of their profits from overseas.

The US Dollar Index used to measure the value of the dollar against a basket of six foreign currencies (the euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona) is up about 16% this year. According to Morgan Stanley, that could translate into a fall of about 8% in earnings per share of S&P 500 companies.

The dollar is expected to continue its dream run and remain strong for at least the next three months, possibly to the end of the year, or at least until the US Federal Reserve (Fed) tempers its interest rate increases.

How much has the dollar risen against other currencies?

The US dollar has gained against almost every other currency in recent months. It’s up 11% versus the euro so far this year, with the exchange rate between the two currencies hitting parity for the first time in 20 years. The USD is also up 13% against the British pound, 20% against the Japanese yen, and 6% against the Chinese renminbi, according to a recent article in Fortune.

Causes of the soaring dollar

The rising value of the dollar is the result of multiple causes: First, the decision by the Fed to begin aggressively raising interest rates in an attempt to rein in inflation and curb borrowing. Second, the geopolitical uncertainty created by the Russian-Ukraine conflict has resulted in global investors seeking safety in US currency and assets, as the US is seen as a source of economic growth and stability. And third, the US is more energy independent than European countries that import more of their oil and gas from abroad.

In times of economic and political turmoil, investors tend to come into dollars, considered the primary safe-haven currency. For investing in US stocks and bonds, traders usually use dollars, which results in driving up the dollar.

US corporations that have been negatively impacted by the surging dollar

An analysis from Bloomberg found that references to “foreign exchange” in earnings calls have hit a three-year high this season.

A strong dollar is weighing on earnings of US companies with large international operations. These American companies derive revenues from overseas and are suffering from the dollar’s strength when they convert foreign sales back into dollars.

Coca Cola, Pepsi, Yum Brands, Procter & Gamble, AbbVie, Pfizer, Johnson & Johnson and Philip Morris have been impacted by the surging dollar that will exert a drag on their profits and lower revenue forecasts. Technology titans such as IBM, Salesforce, Apple, Meta Platforms, Alphabet and Netflix could be particularly hard hit since they generate the biggest portion of their sales outside of the US.

Last week, IBM warned that the strengthening dollar could reduce its revenues this year by $3.5 billion, including about $900 million in the second quarter. Microsoft also trimmed its sales forecasts based on the rising and valuable dollar. Salesforce lowered its revenue guidance due to the surge in the dollar and expects to have a $600 million negative impact on revenues this year. 

Netflix blamed the dollar’s historic run-up against most other currencies for putting a serious dent in its revenue growth as it took a $339 million sales hit in Q2 (April-June) 2022. The outlook for the third quarter is even worse because Netflix says 60% of its revenue comes from international markets, but nearly all of its expenses are in dollars.

The S&P 500 Foreign Revenue Exposure Index has dropped around 17% so far this year, compared with the broad S&P 500 index’s 13% decline. Meanwhile, the S&P 500 U.S. Revenue Exposure Index, which includes companies more dependent on domestic sales, has lost just 7%.

Effects of the dollar’s historic surge on US multinationals

A strong dollar is a windfall for US consumers, particularly for US tourists traveling abroad who will find that their money goes further than it used to. Imports or goods imported from countries whose currencies have dropped against the dollar have become cheaper. But for American companies that have big international footprints or sell products or services abroad, it is taking a toll.

The strengthening of the dollar makes American manufactured products or exports more expensive overseas, which means foreign buyers need to pay more in local currency to purchase those goods. This deflates or lowers the value of international revenue generated by American multinational companies once it is converted into US dollars.

The rising cost of US products can lead to a decline in demand and make American manufacturers less competitive, as overseas importers or foreign buyers look to alternative markets to source goods. These factors can hurt corporate America’s bottom line, especially businesses with global operations, as an 8–10% increase in the value of the dollar can lead to a 1% drop in US corporate profits, according to Credit Suisse.

Disadvantaged US manufacturers may feel pressured to look for ways to cut costs to keep their prices competitive and maintain their margins. Furthermore, when exports become more expensive, it could mean expanding imports and declining exports add to the growing US trade deficit, leaving US policymakers with a conundrum – do they choose inflation or more trade deficit?

If US multinational companies are concerned, then many foreign companies doing business in the US are benefitting from the mighty dollar, as their products are now cheaper to import into the country. Also, a rising dollar “inflates the value of U.S.-generated revenue on a foreign company's balance sheet once it's converted to a local currency,” as per a recent article published in Fortune.

According to Fortune, on July 15, British luxury retailer “Burberry forecast that the strong dollar would boost its overall fiscal performance, increasing its full-year sales by almost $200 million. That cushioning is welcome news for Burberry; its sales in China—the source of a third of its sales—sunk by 35% this quarter due to the country's COVID lockdowns.”

US companies reviewing hedging strategies

In light of the strong dollar, US companies are reviewing their hedging strategies. They now have more tools at their disposal to hedge foreign currency swings and risks and provide them visibility into what future overseas revenue may look like.

The Wall Street Journal reported in late June that “Beverage maker Coca-Cola saw a roughly $200 million negative impact on its first-quarter operating income, which came in at $3.4 billion, up 25% compared with the prior-year period. The company has about $7.6 billion in notional foreign-exchange cash-flow hedges in place.”

Corporate treasurers have been actively building foreign exchange hedge positions via forwards and options contracts, “as well as instruments like knock-ins and knock-outs, which allow companies to seek the protection of a hedge only at certain exchange rates,” the same article detailed in the Wall Street Journal.

Conclusion

Most analysts on Wall Street believe that the dollar will continue to trade higher against major currencies. However, if the US moves into a recession, and the Fed begins to loosen monetary policy, and if Europe’s recent efforts to revive its economy work, it could sap strength from the US dollar and bring it down, easing the travails for US corporations dependent on overseas sales.

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