A slumping dollar in 2019 became a popular market call for many Wall Street strategists at the end of last year, and last week’s dovish message from the Federal Reserve has bolstered the case to some degree. However, it’s far from guaranteed.
When the list of usual suspects blamed for disappointing corporate earnings is compiled for any given quarter, you can often count on two bogeymen showing up prominently: nasty weather and gyrations in currency markets.
While we’ll have to wait until the current quarter is over to see how many fingers will be pointed at the record-cold Polar Vortex, the currency market is playing a starring role as a villain in many U.S. companies’ fourth-quarter results. The ICE Dollar Index jumped more than 10 per cent from its low in February 2018 to its high in November, and its average level last quarter was 3 per cent higher than the previous year’s period. Call it the Dollar Vortex. And unlike the cold snap that froze much of the U.S. last week, there’s no guarantee of a spring thaw.
“That’s a fast move and a big move, and there’s always a lag for it affecting the economy,” said Jim Paulsen, chief investment strategist at Leuthold Weeden Capital Management in Minneapolis. “When you increase the dollar, overnight you change the competitive status of American products.”
The pain is not spread evenly around the U.S. corporate landscape, and a strong dollar is actually good news for many import-reliant consumer companies because it results in greater buying power overseas. But the currency’s strength underscores the challenges that many of America’s corporate giants faced amid global trade tensions, a tighter U.S. rate policy and concerns about China’s economy. Every 7 per cent to 8 per cent move in the dollar results in a 1 per cent move in the opposite direction for U.S. corporate profits, according to Jonathan Golub, chief U.S. equity strategist at Credit Suisse Group.
International Business Machines Corp., which books more than half of its sales outside of North America, took a $500 million hit to revenue in the fourth quarter, $150 million more than expected. Johnson & Johnson, which relies on markets outside the U.S. for almost half of revenue, saw international growth nearly wiped out by fluctuating exchange rates in the same period. And United Technologies Corp. also said the foreign exchange was a headwind in the quarter.
Exchange rates weren’t any friendlier to companies in the third quarter. North American companies collectively reported an $11.8 billion hit in that period because of negative currency impacts, nearly 12 times greater than the second quarter, according to FiREapps, a Scottsdale, Arizona-based company that advises businesses and makes software to help reduce the impact of currency swings. Third-quarter results showed that the number of companies mentioning negative currency effects was six times greater than the previous quarter, according to FiREapps Chief Executive Wolfgang Koester.
“That shows you that this is a major impact and that’s not about to stop, in my opinion,” Koester said in a Jan. 30 interviews.
The magnitude of the currency drag appears to have caught many businesses off guard. The ICE Dollar index jumped 4.4 per cent last year, the most since 2015. Not all companies hedge currency risk. Even for those that did attempt to guard against a rising dollar, the extent of the strength means that these efforts, typically done with forwards and options, may not have been very effective.
“They perhaps weren’t as fully hedged or weren’t fully prepared for it and that’s why we are getting this repeated reference to the adverse translation effects of the stronger dollar,” said Daragh Maher, U.S. head of FX strategy at HSBC Securities.
At toolmaker Stanley Black & Decker Inc., Chief Executive Officer James Loree told analysts on a Jan. 22 call that “our teams acted with speed and agility” to combat an unprecedented impact from not only currencies but also commodities and tariffs. While he expects the headwinds to gradually abate this year, “they will be with us for a while.”
Loree is not alone. He joins a chorus of executives warning of more pain ahead for corporations with large overseas customer bases. Companies from Pfizer Inc. to DowDuPont Inc. and McDonald’s Corp. have already warned about the ripple effects of a strong dollar in 2019 — particularly in the first half of the year.
This comes amid a backdrop of global uncertainty on the U.S.-China trade war, Brexit and fears of a potential worldwide economic slowdown that’s making the task of currency forecasts trickier for corporate treasurers. A slumping dollar in 2019 became a popular market call for many Wall Street strategists at the end of last year, and last week’s dovish message from the Federal Reserve has bolstered the case to some degree. However, it’s far from guaranteed. HSBC strategists, including Maher, believe the dollar “is still placed to strengthen in most scenarios,” according to a Jan. 31 note.
Last year’s off-target forecasts for a weaker dollar are casting suspicion on Wall Street’s prediction that the currency will weaken by almost 5 per cent by the end of 2019, according to the Bloomberg median forecast. Either way, major corporations may have learned enough from this year to take precautions.
“With companies suggesting the headwinds will continue, that would marginally suggest that they are maybe better prepared now for dollar strength if that’s what we get,” said Adam Cole, chief currency strategist at Royal Bank of Canada in London, who believes the dollar will strengthen.