Strengthening of the Dollar

Since the second quarter of 2014, the U.S. dollar has grown in strength against several global currencies, such as the euro, the pound, the Swiss franc, the yen, the real, etc. The recovery of the U.S. economy and the weakening of economies in the Eurozone, China, Japan, and developing countries seems to be the reason for this behavior.

However, the currency which has lost the most ground against the dollar is the euro, which traded at the lowest level in nine years during the previous month. The U.S. economy has grown by 5 percent in the third quarter of 2014, unemployment is continually falling, and low levels of inflation are being recorded. In contrast, the Eurozone economy has not recorded growth in the second quarter of 2014, with ongoing high levels of unemployment and a negative annual inflation rate of -0.2 percent recorded in December 2014, principally as a result of the reduction in energy costs, which is a product of the fall in the price of oil.

Faced with the Eurozone’s sluggish economy and the non-existent impact of the base interest rate, which has remained close to zero during the course of 2014 (it is currently at 0.05 percent), the European Central Bank will shortly apply the unconventional measure — called quantitative easing — of printing euros in order to acquire government bonds, with the aim of reducing interest rates in the long term and injecting liquidity in order to encourage consumption and investment. This impending move is causing investors to undo their positions in euros and seek safer and more profitable investment alternatives such as U.S. government bonds, a situation that is contributing to further weakening of the euro.

For economies that export goods (such as Japan, Germany, Italy, etc.), the weakening of their currencies against the dollar helps to improve their exports, because as the prices of these goods pay contributions in local currency, importers require fewer dollars to purchase them. However, this is not the case in economies that export raw materials, because the prices are quoted in dollars, and consequently demand may be adversely affected by those importing countries whose currencies are weakening against the dollar, as they would be required to use a greater amount of local currency to pay for raw materials. Accordingly, in a scenario that further strengthens the dollar, it is possible that the prices of raw materials could continue to fall.

While the European Central Bank is open to applying unconventional measures, the U.S. Federal Reserve, which ceased applying these measures in October 2014 due to the recovery that the U.S. economy recorded, is considering raising the base interest rate (currently between zero and 0.25 percent) at some point in 2015. If this were to happen, the dollar would continue to strengthen, because it would be more attractive to invest in the U.S., where the best interest rates would be paid. But it would not be good news for companies in that country, because they would have to pay a higher financial cost, and with a strong dollar, they would export less. It will depend on growth, unemployment and inflation (favored by low oil prices) in the U.S. economy during 2015, for which the Federal Reserve will make the decision on whether to raise the base interest rate or not, and if so, at what point to do so.