With inflation in the U.S. spiking to 9.1% in June, the highest level in four decades, the market’s primary worry right now is the rapid deterioration of consumer spending power. However, many investors are overlooking another worrying sign that will affect multinational companies in particular: the rising value of the dollar is set to decimate international sales thanks to unfavorable exchange rates.
For U.S. companies that make significant portions of their revenue from other countries, this could be devastating, so investors need to brace for impact.
Multiple factors are driving up the dollar’s value
The U.S. Dollar Index measures the strength of the U.S. dollar against a basket of six major foreign currencies: the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona and the Swiss franc. As of July, this index is at its highest level since 2002.
There are multiple factors driving up the dollar’s value. First and foremost is inflation, which is the direct cause of the second factor – rising interest rates.
The U.S. Federal Reserve being one of the most hawkish central banks among developed countries is exacerbating the difference in strength between the U.S. dollar and its peers. For example, the European Central Bank has its base rate at -0.50% and is only just now considering a 25 basis point increase, while the Bank of Japan is still pursuing easy monetary policies.
Additionally, rising geopolitical instability is causing higher demand for the dollar as a safe-haven asset. U.S. Treasury securities are in high demand as interest rate hikes make them a more reliable store of value than many other assets.
While U.S. investment-grade debt could suffer from high exposure to international markets, high-yield debt might be relatively isolated from this due to its mostly domestic exposure.
Russia’s war on Ukraine has served not only to drive inflation, but also to weaken and fragment European markets. On July 13, the euro fell below parity for the first time since 2002, meaning the currency now exchanges for less than $1.
Further pain is in the cards for multinationals
While a stronger dollar certainly helps to preserve the value of the currency as the global standard, in the current economic environment, it does mean that U.S. companies earning a significant percentage of their income from international customers will see their profits suffer.
Due to the enormous impact of the war in Ukraine and resulting effects on the energy market, companies with high exposure to Europe or emerging markets are more likely to be negatively impacted by currency adjustments than those with high exposure to Japan or China.
Last month, Microsoft Corp. (MSFT, Financial) warned of a $460 million hit to its fiscal fourth-quarter revenue because of currency fluctuations. That does not necessarily mean the company will post a bad quarter, as its cloud business is expected to cross the $100 billion annual run-rate level for the first time in the fourth quarter. However, in a bear market, any disappointment can hurt share prices.
Alphabet Inc. (GOOG, Financial)(GOOGL, Financial) generates more than 50% of its sales overseas, giving it high exposure to foreign exchange risk. However, Alphabet makes a point of covering its currency exchange risks through currency options, which could help protect it.
One company worth watching is Apple Inc. (AAPL, Financial), which generates 24% of its sales in Europe and 19% in Greater China. Both Apple and Tesla Inc. (TSLA, Financial) are expecting numbers to be affected by China’s zero-Covid policy as well, which has caused factory shutdowns. About a quarter of Tesla’s sales come from developing nations, including China. Foreign exchange risk in China should be mitigated by government intervention to keep the yuan stable against the dollar.
Semiconductor stocks are likely to be among the most impacted by currency exchange headwinds. Nvidia Corp. (NVDA, Financial), for example, has significant exposure to the Japanese yen and the Chinese yuan; 84% of its sales are international. Qualcomm Inc. (QCOM, Financial) has 94% international exposure. Earnings results in this sector could still be bolstered by strong and growing global demand, but near-term pain is possible as Micron Technology Inc. (MU, Financial) forecast in its latest quarterly report.
Many oil and gas companies have significant international exposure as well, but this is highly unlikely to make a noticeable impact on their earnings as the geopolitical situation continues driving fossil fuel prices through the roof.
Takeaway
A variety of factors are causing the U.S. dollar to strengthen against many foreign currencies, including major ones like the euro and yen.
This is likely to negatively affect the sales of companies with high exposure to international markets, though whether or not this will override domestic inflation, pricing power and growth remain to be seen, especially with big tech names like Alphabet and Nvidia.
On the other hand, a stronger dollar does have the ability to moderate inflation due to increasing its purchasing power for foreign goods, and it also reinforces the dollar’s status as a safe-haven asset.
