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Morning Notes — Strong Dollar Headwind

Strong Dollar Headwind

February 20, 2020

In the long-run, currency exchange rates are mostly influenced by an economy’s current account balance. The ‘current account’ is simply the trade balance plus net income and direct payments. The currencies of countries with a current account surplus are supposed to trade at a premium to those with a deficit and vice versa. But in the short-run, currency exchange is most heavily influenced by growth and interest rate differentials paid on cash deposits. Notwithstanding its current account balance (deficit decreased in recent quarters), the US economy has recently been the most resilient of the developed economies. The Fed has maintained its ‘appropriate’ stance, and cash earns a high relative interest rate. The coronavirus is expected to impact Asian economies more than the US and more than Europe (has more export exposure to Asia than the US). The recent appreciation in the dollar shouldn’t come as a shock to anyone, but the magnitude might. The dollar has been especially strong vs yen following Monday’s surprise preliminary Q4 GDP miss out of Japan (-6.3% vs consensus for -3.8%). This is the first cut at Q4 GDP (there will be subsequent revisions), but Q4 had no coronavirus impact and the wide miss increases the probability of a second consecutive contraction in Q1. Of course, two successive quarters of GDP contraction is the definition of ‘recession,’ which has investors on edge given the BOJs relatively light monetary toolbox.

Read on for the SPX impact…

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