Here’s What Happens If The Dollar Keeps Rising

From Boris Schlossberg: As the new year draws near, we have seen very little consistency in the performance of the U.S. dollar. The greenback has been moving back and forth and we are still seeing more profit taking than new positioning in the dollar.

Of course, this isn’t a surprise as overstretched moves around major holidays invites liquidation. We could see one final jolt of volatility with the markets in full holiday mode this week.

Short-term price action aside, with the Federal Reserve looking to raise interest rates three times next year, 2017 should be a good year for the U.S. dollar. That is, unless the strong dollar kills corporate earnings, Trump tantrums overshadow Trump stimulus, and the Fed raises interest rates two, instead of three times next year.

Time and again we’ve heard U.S. companies attribute earnings misses to currency translations. A strong currency hurts corporate earnings by reducing the value of foreign profits and making U.S. exports less competitive on the global market. According to Factset data, 30% of U.S. based S&P 500 firms draw over 50% of their revenue from outside the U.S. and the value of this revenue is now less in U.S. dollar terms.

We were having this same conversation this time last year when USD/JPY was trading above 120. The strong dollar was also a big problem then, and in less than 6 months, it sank down to 100.

There are no less than 10 key consequences of a strong dollar (list below) that investors need to keep a watchful eye on in 2017. And with this in mind, it would be dangerous to expect an uninhibited rally in the dollar next year, especially since it’s a crowded view.

10 Consequences of a Strong Dollar:

1. Less Exports, More Imports, Wider Trade Deficit

2. Lower Inflation

3. Lower Commodity Prices

4. Weaker Earnings for U.S. Companies with Significant Foreign Revenue

5. Less Pressure on Major Central Banks like ECB to Ease

6. More Pressure on Emerging Market Nations with Dollar Denominated Debt

7. More M&A Transactions (which may not be a consequence)

8. Weaker International Investment Returns

9. More Pressure to Outsource

10. Less Demand for Currency Alternatives such as Gold and Bitcoins

In the coming year, if there are any delays to Donald Trump’s fiscal stimulus program or there are signs that it may not be as aggressive as he promised, the rally in stocks and the dollar could be unwound. Any of this could lead to less tightening from the Federal Reserve next year, which is also dollar bearish.

Of course, if none of this becomes an issue it should be smooth sailing for the buck. This could easily result in parity — or below for the Euro/USD exchange rate in 2017. And we expect the 120 level in USD/JPY to be reached sometime in the coming year as well.

The PowerShares DB US Dollar Index Bullish (NYSE:UUP) was unchanged in premarket trading Wednesday. Year-to-date, UUP has gained 3.78%, versus a 12.14% rise in the benchmark S&P 500 index during the same period.

UUP currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #1 of 25 ETFs in the Currency ETFs category.

This article is brought to you courtesy of Money And Markets.

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