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As the Dollar Strengthens, the Impact on Trade Could be Significant

The dollar’s rebound against the euro and other currencies in the last year has helped to strengthen export values, but it’s also raised the cost of imports and the specter of inflation in the U.S. economy.

The dollar has risen to about $1.24 to the euro compared to $1.09 a year ago and $1.05 at the end of 2016. The dollar’s value against the Chinese yuan had increased to 16 cents from 14.5 cents a year ago, as China’s economy—while showing some recent improvement—has been stagnant.

Measuring the dollar against several other currencies of key trading partners, it has gained strength against the British pound sterling to reach $1.42 this week versus $1.28 a year ago, while the U.S. currency has rebounded against the Japanese yen in the last month to get 107.37 yen to the dollar compared to low of 104.7 in late March.

The U.S. dollar index, which measures the dollar’s strength against a trade-weighted basket of six major currencies, was up 0.12% to 89.46 on Thursday.

“The euro is fairly valued in that the appreciation we’ve seen is mostly due to the fact that the Euro Zone has a very low inflation rate,” Sara Johnson, executive director of global economics at IHS Markit, said. “On a trade-weighted basis, the euro is currently about at its historical average, whereas on a nominal basis it looks strong.”

A trade-weighted basis is a measurement of a currency compared against others currencies. Nominal refers to the unadjusted exchange, without taking elements such as inflation and seasonality into account.

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With regard to the dollar, Johnson said, “Although the euro has appreciated some in the past year, I wouldn’t say that the euro is expensive or the dollar is cheap. There’s been an adjustment, but the dollar is still relatively strong and that’s a factor that will probably make the dollar a drag on the U.S. economy for a couple of more years.”

IHS Markit expects that with the Federal Reserve raising interest rates more aggressively than the European Central Bank, there’s likely to be some continued recovery of the dollar versus the euro over the next nine months.

For importers and exporters, the exchange rate is sort of a return to some balance compared to a few years ago, when the weak euro made it difficult, for example, for European fabric firms and brands to export to U.S. manufacturers and retailers.

European luxury firm LVMH Moët Hennessy Louis Vuitton noted “unfavorable exchange rates” in reporting its first quarter financial results this month, with a currency effect of 10 percent in measuring real versus organic growth year to year.

On a broader scale, however, Italy’s apparel and textile imports to the U.S. rose 23 percent to $311 million worth of goods in the first two months of the year compared to a year earlier, while Germany’s increased 26.5% to $70.5 million and France’s were up 18 percent to $49.3 million.

“The correction we’ve seen in the dollar in the last year helps to level the playing field and I would expect most U.S. exporters will be in a good position this year,” Johnson said.

IHS expects exports of goods and services, which rose 3.4% last year after two years of no real growth, will increase 4.3% this year and about 6 percent annually in the next two years. U.S. exports of apparel and textiles increased 3.47% in February to $22.83 million, with the bulk of the shipments and increases to Western Hemisphere countries.

IHS Markit, in its April World Forecast Flash, predicted a continued strengthening of the euro against the dollar to 1.21 euros to the dollar at the end of this year from 1.2 at the end of 2017, and rising gradually to 1.25 euros to the dollar by the end of 2020.

While currency is a factor in trade, Johnson said, “The more significant driver of trade will be the relative strength of the two economies. Certainly, the combination of tax cuts and additional federal spending will boost import demand from the U.S. this year and next year that’s likely to widen the U.S. trade deficit.”

The Congressional Budget Office has estimated that the federal budget deficit will total $804 billion this year and exceed $1 trillion a year starting in 2020.

Economists have said that U.S. exports could come under pressure if China or other countries ramp up tariffs on U.S. products, which would reduce demand for dollars and potentially widen the trade deficit the Trump administration is attempting to close.

In an April U.S. economic forecast, Johnson and IHS Markit chief U.S. economist Joel Prakken wrote they see “solid growth with higher inflation out of the gate,” for the U.S. economy.

They noted that fourth-quarter gross domestic product (GDP) growth was 2.9%, with strength in personal consumption expenditures and inventory investment.

“While the economy surely had solid momentum heading into 2018, the incoming data point to a temporary slowdown in the first quarter,” the economists wrote. “Following only 1.7% growth in the first quarter, we forecast GDP growth to pick up to 3 percent or better over the balance of 2018, followed by 2.9% next year and 2.1% over 2020. This growth is aided by recently legislated tax cuts and new federal spending, and not at all derailed by new tariffs on imports of steel and aluminum, since the growing list of exemptions from these tariffs has mitigated their effect.”

Johnson and Prakken noted that core inflation is picking up, rising 2.3% over the six months through February. They forecast core inflation of 2 percent for this year, 2.2% over 2019 and 2.3% inflation over 2020.

As for Europe, the report noted, “The Eurozone economic expansion is still on firm ground, but evidence is building that the high-water mark for growth was reached in the second half of 2017. Recent data on inflation, output and retail sales have been disappointing. Eurozone real GDP growth is projected to ease to 2.3% this year, 2.0% in 2019 and 1.8% in 2020, returning to a pace closer to medium-term potential.

Also key for the apparel and textile industry is the strength of China’s economy. IHS said in a report this month that a US-China trade war would have major spillover effects, as foreign-invested firms in China account for more than 40 percent of China’s exports. China’s first-quarter real GDP growth held steady at 6.8% year on year, sustained by a stronger industrial sector, robust retail sales and rising foreign demand. IHS Markit expects growth will ease to 6.7% this year, 6.4% in 2019 and 6.1% in 2020.