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Double Trouble: A Strong Dollar and Rising Oil Prices

Oct 4, 2023

The U.S. dollar and oil prices are surging in tandem, creating a dual threat for global economies, companies and consumers. How can investors prepare?

Author
Lisa Shalett
Lisa Shalett

Key Takeaways

  • A surging dollar could weigh on U.S. corporate profits, strain emerging economies and weaken global consumer spending.
  • Rising oil prices could exacerbate these challenges globally and, in the U.S., add to households’ financial pressures.
  • Investors may want to stay defensively positioned, with an emphasis on quality stocks and intermediate-duration bonds.

U.S. markets are currently seeing an anomaly that may prove challenging for global economies. The U.S. dollar and oil prices, which historically  have an inverse relationship, have both been surging: The U.S. Dollar Index, which tracks the value of the dollar against a basket of major world currencies, has risen to its highest level since November, while West Texas Intermediate, the main U.S. oil benchmark, recently pierced the $95-per-barrel mark for the first time in about a year.

 

What could this mean for economies and markets? A stronger dollar and rising oil prices could have widespread impact across economies, industries and consumers. Here’s who could bear the brunt:

  1. 1
    U.S. exporters and multinationals:

    A stronger dollar typically makes U.S. exports more expensive abroad, diminishing U.S. exporters’ ability to compete on price. It also reduces U.S. companies’ overseas earnings when they convert from local currencies into dollars. This is a significant issue, since approximately one-third of the profits of S&P 500 companies are exposed to these forces. On top of that, rising energy prices add cost pressures for U.S. companies that are dependent on global supply chains and transportation as well as energy-intensive inputs like chemicals and plastics.

  2. 2
    Emerging markets and other economies that import oil and depend on dollar-denominated debt:

    Crude oil has rallied more than 30% from this year’s low, generating higher costs for major energy importers—including Japan, India, South Korea and Germany—that could adversely affect their economic growth. In addition, many economies, including in Asia and Latin America, have borrowed heavily in U.S. dollars; when their currency weakens against the dollar, repaying those debts becomes more expensive. This dual blow to emerging markets and other economies could weigh on global economic growth, which has been estimated to improve in 2024 but might end up disappointing and creating volatility in markets.

  3. 3
    Global consumers:

    Outside of the U.S., a stronger dollar may limit demand for products made in the U.S. as they become more expensive, limiting consumers’ buying power. Meanwhile, U.S. consumers will be coping with higher gasoline prices, which almost always translate into lower discretionary spending, in addition to existing pressures including depleted excess savings, swelling credit card balances and the resumption of student loan repayments. 

All of these circumstances are sources of economic and market uncertainty and are apt to challenge corporate profits. Exacerbating the outlook is the fact that analysts have been boosting their U.S. corporate earnings forecasts for the past couple of months, now anticipating 12% annualized growth through 2025. Higher expectations, in the face of mounting risks, may amplify the degree of potential disappointment and related market volatility.

 

In light of these trends, investors should consider remaining defensively positioned. As noted previously, now may be a good time to consider balancing equity allocations in your portfolio between offense and defense, with a particular focus on quality. In fixed income, consider moving toward intermediate duration, where historically high yields are emerging. Lastly, look to harvest some investment losses for tax purposes, including in municipal bonds, preferred securities or Treasuries.

 

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from October 2, 2023, “A Double Whammy.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

Risk Considerations

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

The value of fixed income securities will fluctuate and, upon a sale, may be worth more or less than their original cost or maturity value. Bonds are subject to interest rate risk, call risk, reinvestment risk, liquidity risk, and credit risk of the issuer.

High yield bonds (bonds rated below investment grade) may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk, price volatility, and limited liquidity in the secondary market. High yield bonds should comprise only a limited portion of a balanced portfolio.

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Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

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Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.

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