Impact of Stronger Dollar on Q2 Earnings

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The U.S. dollar continued to trade lower this morning as investors reduce their long positions ahead of Bernanke’s testimony on Wednesday. While this morning’s U.S. economic reports support the Fed Chairman’s decision to reduce asset purchases, they are not significant enough to alter the market’s caution ahead of his trip to Capitol Hill.

Before we get to the data, we are in midst of earnings season and are beginning to see companies attribute misses to a stronger dollar. Revenues for Coca-Cola fell short of expectations because of weaker sales volume and a stronger dollar. They said currency fluctuations cut 2% off comparable net revenues and 3% off comparable operating income in the quarter. Coke is negatively affected by a stronger dollar because they are a global brand whose foreign revenues far exceed domestic revenue and the value of sales abroad are weakened by a rising U.S. currency. Johnson & Johnson who reported a nice jump in second quarter profits also said unfavorable exchange rates reduced revenue by 1.5% in Q2. While the dollar index ended the quarter virtually unchanged, there was quite a bit of volatility between April and June with the index even a 2.5 year high during the quarter before sinking sharply lower. As earnings season continues, investors should be aware that the results of many companies could be negatively affected by currency fluctuations in Q2.

As for the overall economy, the manufacturing sector continues to recover with industrial production rising 0.3% in the month of June, up from 0% the prior the month. Inflationary pressures are also heating up with CPI growing 0.5% last month, bringing the year over year increase from 1.4% to 1.8%. However excluding food and energy, consumer price growth maintained a steady pace of 0.2% as a large part of the headline increase can be attributed to gas prices.

The reason why we expect Bernanke to sound more cautious is because members of Congress will be looking for reassurance that by tapering asset purchases, the Fed will not send the U.S. economy into a downward spiral and to do so, Bernanke will stress that there will still be plenty of underlying stimulus in the economy. While Bernanke could point to recent improvements in the U.S. labor market as reasons for why they plan to shift monetary policy, areas of weakness such as retail sales will force the Fed Chairman to acknowledge that the economy still needs help. The prospect of dovish comments from Bernanke has and could continue to keep the dollar under pressure ahead of tomorrow’s key event risk.

Kathy Lien
Managing Director

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