The foreign subsidiaries of U.S. companies are suffering from the robust dollar.
American firms had a rocky beginning in 2015 as their profits from overseas subsidiaries dropped significantly. Is the strong U.S. dollar to blame for the fall? Two Fed economist might have the answer.
The American Q4 corporate profits fell about 1.4 percent last year before shrinking 5.2 percent in this year partly moved by the fall of U.S. companies’ affiliate earnings. There are two key reasons for that: the appreciating dollar, falling oil prices, around third of the profit fall specifically came from the cheaper petrol dollar, explained Carol Bertaut and Nitish Sinha in a post this month.
The two Fed policy makers have expressed their concern about the bullish dollar’s unfavorable effect on exports in Federal Open Market Committee minutes and speeches. Meanwhile Fed officials are considering to raise the interests rate after 9 years.
The dollar has strengthened by about 9.6 percent versus the European common currency and 3.4 percent against the Japanese yen this year. Stronger USD damages company earnings because goods produced abroad become more competitive with U.S. exports, and if companies haven’t hedged overseas profits, they could mean fewer dollars.
The Federal Reserve analysts estimated how two factors majorly weighing on exports right now — strong dollar and cheap oil from abroad — are contributing to the drop in income earned by foreign associates. The analysis found that the falling gas prices and the rise of the dollar value could have cut into direct investment income receipts by 14.5 percent between the end of September 2014 and the end of March, with 5.6 percent tied to the dollar’s rise. A drop in oil prices weighs on energy and utility companies.
By studying financial markets, the financial experts also found that market investors and speculators including the strong dollar into their expectations in terms of corporate earnings and portfolio allocation, helping the shares of companies with high overseas sales to weaken as the dollar began its rise last summer.
“An encouraging sign from financial markets is that much the effect of the dollar’s appreciation since last summer may have already shown through to U.S. corporate profits, given the recent stability in stock prices of internationally exposed firms and in the analysts’ expectations,” explained the economists in their paper.
Their forecast could be imperative to Fed decision makers as they try to calculate where the U.S. economy is heading as they are preparing for their big policy move.