Friday, February 19, 2010

U.S. Dollar Strength Will Reduce U.S. Corporate Profits

During much of the stock market rally, one factor driving the rally was the weak U.S. dollar, which was likely to boost corporate profits both by increasing margins or competitiveness of U.S. exporters and by increasing the dollar value of the profits of foreign subsidiaries of U.S. companies (while higher import costs for U.S. companies would partly offset this, the net aggregate effect was clearly positive).

Now that the U.S. dollar has again started to rally this will negatively affect corporate profits. As the rally has been particularly strong against the euro (+12% from the November lows) and the pound (+9%) and as euro area and the U.K. aren't among the biggest trade partners, but do have large domestic markets where subsidiaries of U.S. multinationals earn much of their profits, the negative effect will mainly come in the form of reductions in the dollar value of the profits of foreign subsidiaries.

The markets haven't appeared to notice this yet, but ultimately they will as profits falls as a result.