Stocks and bonds sold off in April as interest rates continued to rise and the U.S. dollar index hit a 20-year high. All else equal, a stronger dollar applies downward pressure to inflation as imports become cheaper. The strengthening dollar and rising interest rates are not unrelated. Europe and Japan’s central banks are hardly budging to combat inflation through higher interest rate policies. As interest rates rise in the U.S. relative to these countries, foreign investors are incentivized to sell their home currency/assets and invest in the U.S. to earn the higher rate. Global investors have also sought the U.S. dollar as a safe haven in a time of uncertainty. These cross-border financial flows have a significant impact on exchange rates. The U.S. dollar’s appreciation even comes amid a record trade deficit. The chart below demonstrates the importance of foreign exchange rates in the inflationary environment. Brent crude oil remains well below the 2008 high in U.S. dollars. But when priced in Euros, oil is at a new all-time high this year.
Recently released 1st quarter GDP data revealed a -1.4% contraction as government spending continued to moderate, inventories declined, and the trade deficit widened. Business investment grew at a 9% clip, led by equipment, software, and R&D. Consumer spending shifted away from goods and into services like travel and dining (which may serve to reduce the trade deficit in the future). Continued improvement in labor participation and business investment will be critical to help offset inflationary pressures on the consumer, Russia/Ukraine events notwithstanding.
-Jared J. Ruxer, CFA, MS