In the world of currencies, the dollar is starting to look like a safe home in a tough neighborhood.
A strengthening American economy, combined with a gloomy outlook for growth elsewhere, is pushing the U.S. currency sharply higher.
The dollar is up 6.4 percent against a group of major currencies since the start of May and has risen in three of the past four months. The U.S. currency climbed Tuesday to its highest level in six years against the Japanese yen, and it’s trading at its highest level in 14 months against the euro.
A continued run- up could mean lower prices for imported cars and crude oil. On the other hand, it could also crimp profits for U.S. companies as their goods become pricier overseas.
A stronger dollar starts with a healthier U.S. economy, and recent news on that front has been mostly good. Construction, manufacturing and autos sales have all posted solid numbers.
Those healthy signs have allowed the Federal Reserve to wind down its economic stimulus. The Fed’s next step would be to raise short-term interest rates from their near-zero levels, a move that is expected next year.
Improving growth and the prospect of higher interest rates make the U.S. a more attractive place to invest, prompting people to buy dollars and push up the currency’s value.
At the same time, the outlook in Europe and Japan is less encouraging.
“While consumption here is not booming, it is in a better place than it is in Europe or Japan,” says Russ Koesterich, chief investment strategist at BlackRock.
A look at how a stronger dollar could play out across financial markets and the economy:
LOWER COMMODITY PRICES
A stronger dollar lowers prices for global commodities, which are priced and traded in dollars.
As the dollar rises, commodities such as oil become more expensive for overseas buyers, who have to convert their weaker currencies into dollars. That curbs demand.
The CRB Index, which tracks the price of a broad range of commodities, has slumped 8 percent since the end of June, while the dollar has gained almost 5 percent over the same period.
MORE MONEY IN CONSUMERS’ POCKETS
A stronger dollar is good news for American consumers, and not just those who are traveling overseas. Imported goods such as autos and computers will cost less to buy. That could mean more money in shoppers’ pockets.
“If I’m spending less on imported products, then I have more money left over,” says David Lebovitz, a global market strategist at JPMorgan. “I can increase my overall purchasing, which would be beneficial to the U.S. economy.”
The U.S. economy expanded 2.5 percent last year, and the Federal Reserve expects the growth to continue. The Fed forecasts growth of about 2.2 percent this year and 3.1 percent next year.
For American travelers, it’s a little cheaper to swing through Tokyo or Paris than it was at the start of summer. The dollar has gained 6.8 percent against the euro in the past four months. It now takes $1.29 to buy a euro, compared with $1.39 at the start of May. The U.S. currency has climbed 3.6 percent against the yen in the same period and currently buys 106.20 yen, up from 101.54 in May.
LOW RATES FOR LONGER
The Fed has been able to hold interest rates close to zero for years because inflation has remained tame. Consumer inflation is up a moderate 2 percent over the past year, a level the Fed is comfortable with.
A stronger dollar could help keep rates from rising too fast. It reduces the price of goods that are imported from overseas. And because the U.S. imports more than it exports, price increases, on average, should remain muted.
A HARDER SELL
A stronger dollar also carries risks. It can hurt U.S. exporters in two ways. It makes their products more expensive and less competitive in foreign markets. It also delivers a blow to profits: Money earned in foreign currencies is worth less when converted back into dollars.
Companies that make heavy machinery, such as Caterpillar and Deere, are among the most vulnerable. Consumer goods companies are also likely to feel the impact. Coach, the maker of luxury handbags, said in August that a sales slide in Japan had been exacerbated by the yen weakening against the dollar. Bruce McCain, chief investment strategist at Key Private Bank, says that U.S. manufacturers have slashed costs, helping them to cope with the higher dollar.
“We’re in much better shape to weather the impact of (a higher) currency than we were in the past,” Mc- Cain says.
The dollar has yet to reach the level where its strength would be detrimental to U.S. corporate earnings, says Alessio de Longis, who manages currency strategies for OppenheimerFunds. He says the dollar would have to rise at least another 20 percent before it became a serious problem.
“The dollar rally is a sign that the U.S. economy is in good shape and outperforming,” de Longis says. “It’s simply too early to worry about the impact of a rising dollar on corporate profits.”