Effects of Dollar drop on the US economy
Published: December 21, 2003 Author: Nick Olivari
For Education and Discussion Only. Not for Commercial Use.
NEW YORK, Dec 21 (Reuters) - After months of looking at nothing but the bright side of a weaker dollar, investors are starting to look at the dark side of its struggle against the euro.
Demand for the dollar has been dampened by concerns about the widening U.S. current account deficit and expectations that benchmark U.S. interest rates will remain low.
For most of the past six months, that was seen as positive for the most part, as U.S. goods and services become cheaper compared with those produced overseas. Now though, investors are looking at the pace of the dollar's decline, fearing that an orderly drop in demand may turn into a rout.
Indeed, this past week, several large companies said the weak dollar continues to be a boon to corporate results:
* On Monday, Illinois Tool Works Inc (NYSE: ITW - news) . , whose products include fasteners, Wilsonart laminates and Hobart food equipment, boosted its fourth-quarter earnings outlook and said the weaker U.S. dollar added 5 percent to its revenue;
* General Mills Inc (NYSE: GIS - news) . said on Wednesday its quarterly sales rose 4 percent, to $3.06 billion, with most of the gain due to the weaker dollar, which boosts the value of sales in other currencies.
* Also, on Wednesday, Commercial Metals Co (NYSE: CMC - news) . , which makes steel products, said its fiscal first-quarter profit more than quintupled, citing the weak dollar and continued strong demand from Asia, especially China.
* On Thursday, Nike Inc (NYSE: NKE - news) . said currency market swings, primarily a surge in the euro against the dollar added $30 million or 7 cents per share to Nike's bottom line for its fiscal second quarter.
Even with all these positives, some investors remain concerned.
"It's not the level that concerns me, but how the rapid change affects commerce and the willingness of foreigners to hold and purchase dollar-denominated securities," said Jim Luke, a money manager with Raleigh, North Carolina-based BB&T Asset Management Inc., which oversees $13 billion.
Any rapid change in currency makes it hard for companies to price cross border deals, Luke said, stifling sales.
Worse, if foreign U.S. investors start to abandon dollar-denominated securities on concerns that any profits will be lost as they convert back to their own currencies, U.S. investors may also take money from the stock market in a bid to beat the rush.
"If the dollar's slide is seen as transient, then the market will stabilize as investors realize the damage has been done," said Anthony Chan, senior managing director and chief economist at Banc One Investment Advisors, which oversees $180 billion. "But not even domestic investors are blind and they don't want to be in front of the train."
Few are expecting such a doomsday scenario, but with the dollar at a seven-year low against the Swiss Franc, an 11-year low against the British Pound and the euro enjoying an 18 percent gain this year, investors are hoping that the dollar is closer to the bottom than not.
If that reluctance to hold U.S. securities spreads to U.S. Treasuries, interest rates will also rise, potentially jeopardizing the economic recovery.
Another fear is that the strengthening global economy will make it harder for the U.S. to fund its current account deficit as investors move into strengthening currencies and cyclical economic regions like Asia.
The U.S. also faces a unique problem in that commodities such as oil and base metals are priced in U.S. dollars.
Steven DeSanctis, small-cap strategist with Prudential Equity Group said his biggest concern is that oil prices can stay high in dollar terms, as people outside the U.S. are effectively paying less.
Economies using the euro will see lower energy costs and a lift in their economies, but in the U.S. -- the world's largest consumer of oil -- companies will see profits erode.
Inflation may also revive as a factor as with imports more expensive, local companies feel freer to boost the prices of their goods in the U.S. market without worrying about a decline in sales, DeSanctis said.
In the near term, it is still the silver lining that predominates as the dollar weakness is expected to add about 2 percent, to fourth-quarter earnings for Standard & Poor's 500 companies, according to Ken Perkins, a market analyst at Thomson First Call.
The fear, however, remains that as the effects of historically low interest rates and tax cuts wind down, the dollar's decline will prove more problematic than beneficial.
And that rubicon could be crossed as soon as the second half of 2004, according to Prudential's DeSanctis, "When the economy starts to decelerate."