The U.S. dollar has been on fire for the past year, with the Wall Street Journal dollar index hitting a 20-year high last week.
The dollar benefits from several factors. The first is the Fed raising interest rates, which makes fixed-income investing in the U.S. more attractive than overseas.
The Fed has raised interest rates by 1.5 percentage points since March, and experts expect an additional 0.75 percentage points at its meeting next week. The one-year Treasury note recently yielded 3.08%.
Also boosting the dollar: While many experts fear a U.S. recession is looming, the outlook for much of the rest of the world is worse. Many market participants expect the currency to continue to rise.
The impact of the dollar’s appreciation has been mixed at the macro level. It makes dollar-denominated goods, such as oil, cheaper for the U.S., and the strength of the dollar makes imports cheaper, which can help companies buy goods overseas.
In addition, the expectation that the dollar will continue to appreciate can attract foreign investors to the United States. Although they will pay more in their own currency to buy dollar assets, if the dollar rises further, those assets will be worth more in their own currency.
On the downside, a strong dollar makes foreign currency U.S. exports more expensive, discouraging foreigners from buying U.S. goods. This means that when U.S. companies repatriate foreign exchange earnings from overseas, they are less valuable when converted to dollars.
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The backbone of enterprises such as Microsoft (MSFT) – Get Microsoft Corporation Reports and nike (NKE) – Get the Nike Inc report There have been warnings that the surging U.S. sector will hit their earnings.
Impact on consumers
So what does a rising dollar mean to you?
On the plus side, your dollars will translate into more foreign currency if you travel abroad. So you’ll have more purchasing power on the go.
In addition, U.S. consumers who buy goods from overseas may benefit from lower import prices.
The strength of the U.S. dollar can hurt you if you invest in mutual funds or exchange-traded funds made up of foreign securities. That’s because those securities are now worth less in dollar terms. (Many foreign stock and bond funds hedge their currency exposure, so the value of these funds is not affected by a rising dollar.)
Some investors look to diversify their portfolios through foreign exchange exposure. Currency movements in foreign stock and bond funds tend to work against these investors in the long run.
Therefore, choosing between funds that hedge currency risk or funds that do not hedge currency risk is a strategic choice.