There are risks for the U.S. in a soaring dollar. It gives a competitive advantage to our trading partners. That means it stimulates our imports while depressing our exports. In addition, it depresses the dollar value of profits from overseas. Profits drive employment and capital spending, so weaker profits attributable to the strong dollar can slow the economy down.
There is a strong correlation between the year-over-year growth rates in S&P 500 forward earnings and aggregate weekly hours worked in private industry. The year-over-year growth rate of capital spending in real GDP is also driven by this profits cycle. Forward earnings were up just 1.4% year-over-year at the beginning of March, down from 8.2% at the end of September. That’s the lowest growth rate since December 2009. Before we get all panicky, keep in mind that this drop was mostly attributable to the S&P 500 energy sector, which currently accounts for just 5.3% of S&P 500 forward earnings.
The bottom line is that the Fed has a problem. The Federal Open Market Committee rarely considers the impact of the dollar on the U.S. economy. The subject is almost never discussed at the FOMC meetings. The members of the committee might need to give more weight to the soaring dollar in their deliberations. They have three options for the rest of this year. They can proceed to normalize monetary policy and raise interest rates a few times this year. “One-and-done” is another option. So is “none-and-done.” I still believe that the last two are more likely than normalization given that the dollar will continue to soar if the Fed doesn’t back off.
Source: Ed Yardeni — Ed Yardeni is the president and chief investment strategist of Yardeni Research Inc., a provider of independent investment strategy and economics research for institutional investors.
