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The First Drawback of a Stronger Dollar

The First Drawback of a Stronger Dollar

Kathy Lien, Technical Strategist

With second-quarter corporate earnings hitting the newswires, companies are clearly feeling the negative impacts of currency fluctuations, the most obvious of which has been the stronger US dollar.

The US dollar (USD) continued to trade lower this morning as investors reduce their long positions ahead of Fed Chairman Ben Bernanke's Congressional testimony on Wednesday and Thursday. While this morning's US economic reports support the Fed's inclination to reduce asset purchases, they are not significant enough to alter the market's caution ahead of Bernanke’s trip to Capitol Hill.

Aside from the latest US data, we are also in the midst of corporate earnings season and are beginning to see companies attribute their misses to a stronger dollar.

Revenues for Coca-Cola fell short of expectations because of weaker sales volume and a stronger dollar. The company said currency fluctuations cut 2% off of comparable net revenues and 3% off comparable operating income in the quarter.

Coke is negatively affected by a stronger dollar because it is a global brand whose foreign revenues far exceed domestic revenue and the value of sales abroad are weakened by a rising US currency.

Johnson & Johnson, which reported a nice jump in second quarter profits, also said that unfavorable exchange rates reduced revenue by 1.5% in Q2. While the US dollar index ended the quarter virtually unchanged, there was quite a bit of volatility between April and June. The index even reached a 2.5-year high during the quarter before sinking sharply lower.

As Q2 earnings season continues, investors should be aware that the results of many companies could be negatively affected by currency fluctuations.

As for the overall economy, the manufacturing sector continues to recover, with industrial production rising 0.3% in the month of June, up from 0% the prior month. Inflationary pressures are also heating up, with CPI growing 0.5% last month, bringing the year-over-year increase from 1.4% to 1.8%. However, excluding food and energy, consumer price growth maintained a steady pace of 0.2%, and a large part of the headline increase can be attributed to gas prices.

The reason why we expect Bernanke to sound more cautious is because members of Congress will be looking for reassurance that by tapering asset purchases, the Fed will not send the US economy into a downward spiral. To do so, Bernanke will stress that there will still be plenty of underlying stimulus in the economy.

While the Fed Chairman could point to recent improvements in the US labor market as a reason to shift monetary policy, areas of weakness such as retail sales will force him to acknowledge that the economy still needs help. The prospects for dovish comments this week already has and could continue to keep the dollar under pressure ahead of tomorrow's testimony.

See related: FX Event Risks the World Will Be Watching

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.