Dollar at Davos: Sound and fury...

Dollar at Davos: Sound and fury...

Some controversy in an otherwise optimistic conclave; mixed to good news for the U.S. economy.

“It’s not something we’re particularly concerned about."
Treasury Secretary Steve Mnuchin, on the value of the U.S. dollar

U.S. dollar: Much ado It’s not that Treasury Secretary Mnuchin got it wrong when he said that a weaker U.S. dollar was good for the U.S. Rather, it’s that the statement was perceived as a change in U.S. policy toward the greenback.  And after the 16% fall of the dollar vs. the euro1 over the past year, investors and others had been wondering if the decline reflected U.S. policy.

Rather, it appears that Secretary Mnuchin was merely stating the obvious – that a declining dollar could be additive to U.S. growth if it attracted investors and boosted U.S. exports – and could act to discourage imports, which could in theory also boost U.S. consumption of U.S. goods.

So why the fuss? Two reasons, one of which is that the concept of a strong dollar is perceived, rightly or wrongly, as a show of U.S. strength. That may have been part of the reason for the qualified denial by the White House.

The second reason, the dollar’s effect on the European Union, is arguably more important – and may explain European Central Bank (ECB) President Draghi’s reaction. The dollar’s fall is the euro’s rise – a hefty 20 U.S. cents over the past 12 months, to as high as $1.254 on Thursday. That rise drives down European manufacturing export competitiveness in favor of the U.S. and is a significant headwind for the ECB’s efforts to raise inflation along with growth. Since the ECB would like to normalize its interest rates sooner rather than later, any counter-inflationary force works against the plan.

Is the falling dollar against the euro part of some formerly-secret plan? More likely, the shift is the result of capital flows, as investments in the form of stock purchases head to Europe, where growth is even more visible than in the U.S., and interest rates are at record lows.

U.S. growth: Markets make the call At first glance, the 2.6% annualized GDP growth rate for Q42017 looked disappointing – having missed the consensus expectations of 3.0%.  But consumer spending rose 3.8% and investments in business equipment rose solidly. The final figure was pulled back due to trade and inventories – both famously volatile. With respect to trade, domestic demand boosted imports, but exports softened, highlighting the impact of trade on growth. A falling U.S. dollar might soften the blow in subsequent quarters.


IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.