The European Central Bank (ECB), in its bid to boost the Eurozone’s flagging economy, began its quantitative easing (QE) on Monday. The QE is guiding the long-term bond yields in the region to near zero, while the central bank continues buying the government debt using the newly-printed euros. This should be flooding the markets with euro.
Last Friday, the ECB announced its 1 trillion euro ($ 1.1 trillion) bond-buying program. Since then, and particularly from Monday with the commencement of the QE plan, weakness in the euro grew. The US dollar achieved a 12-year high and has gained over 31% against the euro over the last 12 months.
There are calls now for a one-to-one exchange rate between the currencies, or in simple terms – dollar-euro parity might be in the cards. The parity existed when the euro was introduced, and it happened again in Nov 2002.
Changing money supplies and the contrasting central bank policies between the two regions have been fueling the chances of the parity. Moreover, there are heightened chances of the US Fed raising interest rates and cutting down the money supply. This will further make dollar-denominated assets more valuable.
What Role Does the Dollar Play Now?
Meanwhile, the Dow crashed about 332 points on Tuesday. Data from Wunderlich suggested the S&P 500 has dropped in 19 of the 27 occasions when the dollar strengthened. The Fed’s sooner-than-expected rate hike fears have also been dragging US equities down. So a strengthening dollar cannot be solely blamed for a dip in equities.
The latest slump in the domestic stock markets should not deter the mood altogether. Though there are adverse effects of a stronger dollar, there are positives too. The plunge in the euro — or let’s say the gain in the dollar — bodes well for a lot businesses in the US.
While it does offer Americans a great opportunity to travel to the other side of the pond at a lower cost, a major benefit of a stronger dollar scenario is that it slashes import prices. Moreover, a stronger dollar is said to be beneficial over the long term in drawing more capital to the country.
Speaking of imports, the US is the second largest importer in the world. According to the United States Census Bureau’s numbers for trade in goods with European Union, January imports from the European Union were at $ 31,588.8 million, as against exports of $ 22,265.7 million. Imports had also outpaced exports in 2014, as for imports of $ 417,836.7 million, exports totaled $ 276,698.4.
Separately, US heavily imports vehicle, machines, engines, pumps, pharmaceuticals, aircraft, spacecraft and alcoholic beverage from Germany and France. So these related companies should also be cheering the devaluation of the euro.
On the other hand, the stronger dollar negatively affects exporters. US firms lose out on the competitive space, as US products become more expensive for consumers in foreign lands — Europe, in this instance.
Also, euro-denominated earnings take a plunge. Price adjustments cannot be made straightaway. They need to incur the currency headwinds that affects revenues and profits in U.S. dollar terms.
However, certain US firms this time can move beyond the import advantage as they have a new strategy – “Reverse Yankees” – to offset pressures from the weaker euro.
Reverse Yankees: The Smart Bet by US Firms
Per this strategy, US companies have been increasingly offering euro-denominated bonds. According to Dealogic, euro-denominated issuance by US firms exceeded 33 billion euros in 2015. This is three times higher than the year-ago period’s number. The borrowing cost in euros is at an historic low. It is cheap relatively to dollar funding. Thus, some multinationals are taking advantage of this master strategy.
The Coca-Cola Company KO offered the largest amount ever by a U.S. firm in euro-bonds. In late February, Coca-Cola offered 8.5 billion euros worth of euro-denominated bonds. Very recently, Kinder Morgan, Inc. KMI also priced 1.25 billion euros of euro-denominated bonds. This is the company’s first issuance of bond offering in euros. It is a smart move by the company to enter the European market at a time of record low borrowing costs and a favorable currency exchange rate.
AT&T, Inc. T, The Priceline Group Inc. PCLN and even Warren Buffett’s Berkshire Hathaway Inc. BRK.A have jumped in to reap benefits of the demand and high prices for euro-denominated bonds. Apple Inc. AAPL was pretty fast in noticing the trend and had debuted after issuing 2.8 billion euros of bonds in Nov 2014. The iPhone maker was taking advantage of a market offering the lowest yields in over half a decade as compared to dollar-denominated debt.
Reportedly, US firms are selling euro bonds that offer about 1.5%-1.75% lower yields than equivalent bonds issued in the US. Apart from the lower borrowing cost advantage, the strategy also offers a hedge against currency devaluation risk.
For firms anticipating further strength in the dollar, and thus a weaker euro, paying off the bonds will be cheaper. If the euro improves, these firms may bank on their revenue stream in euros. The firms may lock the current exchange rates by borrowing in euros. They may later on pay off the bonds with their euro revenues.
A strong currency in general may often be seen as a short-term negative, particularly for the exporters. However, importers will always gain and this makes more sense for the US, which is the second biggest importer. The currency-hedging action and the “Reverse Yankees” trend now offer great protection to US firms.
Moreover, expanding in Eurozone through mergers and acquisitions will be cheaper now. In order to utilize this advantage, US healthcare companies have been busy of late in buying European companies.
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