- The dollar has strengthened materially in 2022
- Recently, China’s economy has gone through a significant slowdown
- This has resulted in the US dollar strengthening against the Chinese yuan
The US dollar index is on the move again and is inching closer to moving to its recent highs. It seems that the dollar has found a new currency to strengthen against, and this time it is against the Chinese yuan.
Much of the dollar's strength in 2022 has come against the euro and yen. The falling value of the euro versus the dollar is due to a weakening European economy and a European Central Bank that has lagged a much more aggressive Federal Reserve. Meanwhile, the Bank of Japan's pledge to keep rates low has allowed the dollar to rally against the yen.
With the Chinese economy faltering, new rounds of stimulus, and even a rate cut, the dollar has moved higher against the yuan. Between April and May, the dollar had strengthened materially against the yuan, rising to roughly 6.75 from approximately 6.35 but stalled out.
That all changed over the past week, as weaker economic data and the PBOC move to cut its one-year rate by 10 basis points to 2.75%. That helped to strengthen the dollar against the yuan to around 6.80 from 6.74. It is not a big move to this point, but if the Chinese economy remains weak and its central bank moves to cut rates further, it could strengthen the dollar even more against the yuan.
Of course, should the dollar begin to strengthen against the yuan, it could create another FX headwind for many multinational companies that conduct business in China. This would likely negatively impact revenue and earnings for these businesses, potentially adding further stress to companies that have already seen FX hits this year.
Because China is the US's most significant trading partner, a stronger dollar could also greatly benefit many companies. The stronger the dollar gets against the yuan, the cheaper imports from China will become. This could help some companies offset inflationary pressures here in the US.
Of course, the stronger the dollar gets against all currencies, the bigger the hit for the entire stock market. A strong dollar will negatively impact earnings and sales estimates for the broader indexes. This has already been an issue this year for many companies, but if the trend of dollar strength continues, the more significant the headwind.
The Fed is still likely to be on a path of raising rates for some time while economies in Europe and China struggle. Given that backdrop, it seems likely that the dollar will continue to be a headwind for corporate earnings and stock markets in the foreseeable future, even though it may have stalled out against the euro and yen momentarily.
For now, the dollar needs to be monitored, as it will significantly impact markets.
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