Daily Management Review

US Firms' Earnings Delight Is Dented By The Dollar's Relentless Rise


US Firms' Earnings Delight Is Dented By The Dollar's Relentless Rise
An issue that many American businesses were not prepared to deal with this year is the strengthening dollar.
A lot of market players thought that the dollar would weaken due to interest rate reductions that investors and the Federal Reserve had scheduled for 2024. The U.S. dollar index, which gauges the strength of the dollar relative to a basket of currencies, is up 4% in 2024 and has increased by almost 16% over the previous three months, but those reductions are still to come.
Even if such improvements show how strong the US economy is overall, certain businesses may experience difficulties as a result of the strengthening currency.
Strong US dollar values also reduce exporters' ability to compete by raising the cost of converting international profits into US dollars for multinational corporations. Businesses who want to protect themselves against the strength of the dollar must also invest in hedging techniques that lessen the impact of the strengthening currency on their earnings.
BofA Global Research predicts that for every 10% increase in the dollar year over year, S&P 500 profits are reduced by around 3%.
The most recent quarter saw strong corporate earnings, which contributed to the dollar's rise. According to LSEG IBES, with more than 80% of the S&P 500 having released first-quarter results, corporations are expected to have raised earnings by 7.8%, compared with an April growth estimate of 5.1%.
However, a number of businesses, including Procter & Gamble, IBM, and Apple Inc., have identified foreign exchange as a challenge.
Senior vice president of treasury and finance solutions company Kyriba Andrew Gauge noted that the strong dollar "has caused a lot of consternation." "CFOs are asking their treasury teams to be much more diligent in managing the risk that comes from that strong dollar."
The strength of the US economy is supporting the dollar's rise and lowering expectations for how far the Fed can cut rates this year. Futures markets indicate that investors are pricing in around 50 basis points of rate reduction for 2024, down from a prediction of more than 150 basis points at the start of the year.
Because U.S. yields are higher than those in many other nations, the dollar is more appealing than other currencies.
"With the expectation of lower U.S. interest rates, nearly all FX practitioners were expecting the dollar to be weaker this year," stated Amo Sahota, director of foreign currency risk management company Klarity FX in San Francisco. "Corporates were licking their lips, essentially waiting for that to play through."
The dollar's fluctuations have varying effects on S&P 500 corporations. According to statistics from FactSet, the industries with the most exposure to foreign income are information technology, materials, and communication services, which derived as much as 57%, 52%, and 48% of their total revenue from overseas, respectively.
Coca-Cola revealed a 9% currency headwind in the most recent quarter, citing currency depreciation in regions with high levels of inflation as the cause. Conglomerate 3M said that foreign exchange had a larger-than-expected negative impact on adjusted margins by 0.6 percentage points, while Apple reported a negative impact from foreign exchange of roughly 4 percentage points on its quarterly sales.
Businesses utilise a variety of hedging tactics, such as those that make use of forward and options contracts, to avoid currency rate movements from causing significant drops in earnings.
Even if the dollar has increased, some companies have found that hedging is not as pressing a concern due to quieter currency markets. Still, several organisations that advise businesses on managing FX risk have observed an increase in hedging activity in recent weeks.
Deutsche Bank's currency volatility index dropped to its lowest point since September 2021 in March.
"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."
The low degree of currency volatility, according to Karl Schamotta, chief market strategist at payments provider Corpay, may be leading some businesses to become "almost too complacent about the risks they are facing."
The dollar will ultimately decline, according to analysts at BofA Global Research, but "the turning point has become harder to time."
"The case to hedge USD upside risks for the rest of the year has materially grown for U.S. corporates," they stated.