The US Dollar Is Still King, And Investors Can Make The Most Of It

Key takeaways

• The US dollar rose to fresh 20-year highs this week
• Meanwhile, the euro fell below $1.02 for the first time since 2002
• Rising energy prices, tightening central bank policies and the Russia-Ukraine conflict have dropped euro values while bolstering USD’s appeal
• Some analysts believe the euro could fall another 5-7 cents compared to the US dollar in Q3

The US dollar hit a new 20-year high this week as the dollar index (which tracks the US dollar against six other currencies) shot above 107. This sets the US currency up 12% since January and marks its best year since 2014.

Meanwhile, the euro tumbled this week, briefly trading as low as $1.014 before recovering to rest around the $1.02 mark. Many analysts believe it’s only a matter of time before the euro reaches a 1:1 exchange rate.

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The sudden shift from euro dominance to near-parity comes as rising energy prices, the Russia-Ukraine war and patchwork global central bank policies batter the currencies in opposite directions. At the same time, European economies continue to grapple with inflation and labor unrest woes.

And since the eurozone remains dependent on Russian energy, the US currency’s “safe haven” appeal has strengthened for many investors. As Joe Quinlan, head of market strategy for Merrill and Bank of AmericaBAC
Private Bank, claimed: “Europe is the weakest link in the global economy. They’re in the cross hairs of the war and the energy crisis.”

Hoisting the dollar high

Recently, economists have raised the possibility that a US recession is nigh. The data appears plentiful: interest rates are going up; inflation is at 40-year peaks; and financial markets are officially camping in bear country.

So, why’s the dollar up?

One primary reason for the rising USD is that the US Federal Reserve continues to hike interest rates harder and higher than many global counterparts. As rates rise, US Treasury yields follow, attracting high-yield-seeking investors. Increased demand for dollar-denominated securities boosts the dollar’s value, attracting even more investors.

As rates rise, some analysts worry that tightening monetary policies risk throwing the global economy into a recession. But others believe that this helps, rather than hurts, the dollar. While the US faces its own recession worries, the country’s economy stands on firmer footing than most of the EU. That may entice investors seeking a “safe haven” investment who think the US will weather the storm better.

Driving the euro down

It takes two to tango – so let’s take a quick look at the other half of the equation.

The euro has sagged this year largely thanks to growing recession fears, which partly piggyback on soaring energy prices.

To start, Russia has steadily restricted Western Europe’s natural gas supply, which officials have denounced as economic retaliation for sanctions and military support for Ukraine. Fears of a total cutoff have prompted some countries to warn that industries may suffer rationing to ensure a plentiful supply for schools, hospitals and homes. A pay strike among Norway energy workers this week has exacerbated the problem.

At particular risk is Germany’s large manufacturing base, as the country’s growth model is based largely on cheap Russian energy. Already, Germany has reported its first monthly trade deficit since 1991, thanks in part to Russia’s energy squeeze.

Supply chain and trade disruptions are expected to further constrict the eurozone’s largest economy and even spark a recession.

In response, Goldman Sachs has raised natural gas price forecasts, noting that Russia is unlikely to completely restore energy flows. And a further surge in oil prices – which seems probable if supply issues persist – could further damage a euro buckling under already-high energy costs and expectations of energy non-delivery.

All told, many analysts expect to see the euro hit parity with the US dollar by August. Unfortunately, dwindling currency power could crimp the European Central Bank’s plans to hike interest rates and fight record-high eurozone inflation.

How far could they go?

Historically, the dollar rises prior to rate hike cycles and eases as the Fed jacks the price of borrowing. But unusually, the dollar has shown little indication that it’s ready to slow in the current cycle. Despite annual inflation of 8.6% and three rate hikes this year, the dollar index is up 8% since mid-March.

According to Deutsche Bank’s George Saravelos, the euro could further fall against the US dollar as the central bank continues on its current trajectory. Said Mr. Saravelos: “If both Europe and the U.S. find themselves slip-sliding into a (deeper) recession in Q3 while the Fed is still hiking rates, [a move down to 0.95-0.97 in EUR/USD] could well be reached.”

In this scenario, the euro would have to fall 7% from current levels. Simultaneously, “safe-haven moves” toward the US dollar could become “even more extreme.”

But Mr. Saravelos also notes that: “By contrast, one key catalyst that could reverse the strengthening of the U.S. dollar is a signal that the Fed is entering a protracted pause in monetary tightening cycles, facilitating a release of some of the risk premium baked into the greenback.”

Impact on consumers and businesses

A strong US dollar has its pros and cons.

On one hand, a strong dollar is good news for inflation-battered Americans, as robust currency makes imports cheaper. It also provides a bargain to Americans residing or sightseeing in Europe who take advantage of more favorable exchange rates.

On the other hand, a stronger US dollar makes US exporters’ products less competitive abroad. At the same time, it negatively reflects on US companies’ bottom lines when they convert foreign profits into US currency. Weakening exports could threaten the already-slowing US economy. (We’re already seeing some of these impacts. Recently, Microsoft downgraded its April-June earnings outlook due to unfavorable foreign exchange rate fluctuations.)

The euro’s concurrent slide has similar impacts in the opposite direction, making imports more expensive for eurozone citizens and boosting the region’s inflation woes. Furthermore, a falling euro reduces the value of European sales for US companies and their investors.

Using the US dollar to your advantage

Investors continue to grapple with recession risks, rate hikes and global trade fluctuations. Unfortunately, current data doesn’t make choosing the right path easy.

At the moment, implied volatility remains near 11.2%, reflecting paling growth as investors contemplate USD-EUR parity. Meanwhile, investors have to consider how the US central bank’s aggressive policies stack against the ECB’s lack of rate hikes.

At the same time, US investors are seeing increased volatility in risky assets. And as global economic growth remains disappointingly low, investors of all stripes may consider the US dollar a safe haven while eschewing the falling euro.

Currently, it seems likely that the US dollar will outperform against foreseeable headwinds. As an investor, that’s great news – a stronger dollar is more money in your pocket. (Or brokerage account, as the case may be.)

Better yet, you don’t have to worry about investing alone. Q.ai is here to help you make the most of the greenbacks in your wallet with a slate of easy, smart investments, all backed by top-notch data and the power of artificial intelligence.

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