How the U.S. Dollar Impacts Corporate Earnings

Understanding the Impact of the U.S. Dollar on Corporate Earnings

The U.S. dollar has been on a tear, experiencing its best quarterly performance in seven years. This dollar strength has had a significant impact on corporate earnings, particularly for companies with significant international business operations.

The dollar has been rallying against the euro by 14% and against the Japanese yen by 30%. This currency strength has led to a decrease in the value of foreign currency when converted back to dollars, a phenomenon known as the “currency translation effect”.

The Currency Translation Effect on Corporate Earnings

The currency translation effect can have a substantial impact on corporate earnings. For example, if a company sells goods in the European Union and brings those profits back to the United States, the value of the euros would have been worth about 1,000 euros in March, but as of yesterday, it would only be worth approximately 985 dollars.

This inverse effect is similar to traveling to Europe and having more spending power there compared to the United States.

Companies Affected by the Strong Dollar

Several companies have already reported the impact of the strong dollar on their earnings. Procter & Gamble, for instance, expects to take a hit of 3.9 billion dollars over the next year due to the currency effect.

Netflix and Tesla are among the tech companies that have also mentioned the currency impact in their earnings calls.

Hedging Against the Dollar Strength

Companies can take measures to hedge against the dollar strength. One method is to pay workers in local currency, keeping the currency local and avoiding the need to bring it back to the United States.

Another method is to issue debt in foreign currency, such as corporate bonds denominated in euros, to avoid the currency translation effect.

The Impact on the S&P 500

The U.S. dollar’s strength can have a significant impact on the S&P 500. A two-percent increase in the trade-weighted dollar can subtract about a percent from earnings per share in the United States for S&P 500 companies.

If the dollar basket increases by 10%, it could cut S&P earnings by 15 to 20 dollars per share.

Conclusion

The U.S. dollar’s strength has a significant impact on corporate earnings, particularly for companies with international operations. As the dollar is expected to continue its upward trend, companies will need to adapt and find ways to hedge against this currency risk.

How can companies effectively hedge against the U.S. dollar’s strength to mitigate the impact on their earnings?