The Value of a Dollar

At the beginning of March, the S&P 500 hit another all-time high, but it promptly retreated from that high. Despite another upswing later in the month, it finished the month with a small loss. With the beginning of foreign stimulus programs, rumors of interest rate changes, and lukewarm economic news, investors were reluctant to make large changes to their portfolios. In fact the only significant trend was investors cautiously increasing their exposure to European stocks.

Back in January the president of the European Central Bank (ECB) announced a quantitative easing (QE) program. Much like the similar programs employed by the Bank of Japan and the US Federal Reserve, the ECB’s plan calls for buying bonds to hold down interest rates, encourage borrowing, and stimulate the European economy. March 9th marked the first purchases of the program. Since the ECB’s announcement in January, European stock indexes managed to climb higher, but they gave back some of those gains in March. Meanwhile, the euro continues to lose value and, as the US dollar gains strength, the two stand nearly equal for the first time since 2002.

This shift in the foreign exchange market is significant, and the strong dollar is currently a dominant force in the US markets. With the Bank of Japan and the European Central Bank in the midst of stimulus measures, the dollar is gaining strength relative to the yen and the euro. The increased purchasing power of the dollar provides US investors with an advantage as they invest overseas. Now, while the dollar is strong, they are able to purchase larger positions in foreign assets, and those assets will rise in value when those foreign currencies recover. The downside for the US economy is that this trend encourages investors to seek investment opportunities outside of the US.

In spite of the strengthening US dollar, the US economy continues to recover well. Unemployment numbers are falling and many of the other economic indicators are also showing momentum. This combination of factors means that the US Federal Reserve is starting to think about an interest rate increase. Obviously, any action by the Fed causes disagreement among analysts and economists alike. Some think that a rate increase is long overdue and others worry that the economy is still too fragile, but the improving economic data indicates that rates will start to rise before the end of the year. Since the end of the Fed’s quantitative easing program, the Fed has promised to be “patient” before raising rates. That term has been present in each of the recent official messages from the Fed, but it was notably absent in March. In order to avoid any sort of panic or shock when it announces the first rate increase, the Fed is attempting to delicately communicate its intentions in advance, but most analysts are predicting that the first increase will come in the second half of 2015.