We are in the heat of earnings season, with major banks having reported last week. Overall, financials have performed very well, delivering strong earnings. This week we see earnings from 122 of the 500 companies in the S&P 500. Tariffs are, of course, a central conversation in these calls with investors. We still expect to see earnings growth of 10% or so.
The US dollar has taken it on the chin the past couple of weeks. About 40% of revenue earned by US companies is earned overseas — meaning a weakening dollar is actually a good thing (ironically) for these companies reporting earnings in US dollars. That said, there is substanial worry about the ongoing viability of these earnings if the trade war is not resolved sooner rather than later.
Speaking of the dollar, there is a little-discussed consequence of reforming the US as a non-import-based economy. When the US imports goods, we receive goods and the country that exported those goods receives dollars. So, we get stuff from Vietnam and Germany, for example, and now Vietnam and Germany have dollars. Now, when Vietnam and Germany wish to trade, they can easily trade in dollars because they both have them. This helps make the US dollar the dominant currency in the world (the “global reserve currency”). However, if the US restricts imports, dollars become more scarce on the global stage and that weakens its position as the global reserve currency. This has not been something that has been discussed, but it is a long-term consequence of curtailing US imports.
Trump has now taken aim at Federal Reserve chairman Jerome Powell, and investors have reacted negatively to that. During the campaign, Trump suggested the central bank should be under control of the executive branch, an idea that, if enacted, would be extremely damanging to monetary stability. Countries where central banks are under direct control of political leaders tend to see higher inflation and poorer economic outcomes. At any rate, investors are now wondering whether that was campaign rhetoric or a serious policy proposal.
Chart of the Week
After a period of strengthening relative to other major currencies, the US dollar has given back its gains and has been largely in freefall since the tariff announcement. This week’s chart looks at the Euro/Dollar exchange rate over time. After touching $1 for €1, $1 now buys only €0.87. This can make US goods more attractive to overseas buyers, which might be an economic spur in the short run. However, this dollar slide is widely believed to be a consequence of the flight of capital from the US, which is a larger problem. If the US ceases to be a home for international investment, that means there is less capital to build everything from infrastructure to factories — a longer-term economic negative. As usual, why something is happening is more important than the event itself.
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