The US dollar (DX=F, DX-Y.NYB) has surged into the new year — and its rapid rise could test corporate earnings with the big bank retailers first up to report.
“A stronger dollar is likely to add to a recurring phenomenon into earnings season — an increase in dispersion of earnings per share (EPS) revisions,” Morgan Stanley analyst Mike Wilson wrote in a note to clients on Monday.
In other words, a strong US dollar will adversely impact companies that do most of their business overseas, like consumer goods and household products, as it will lead to slower earnings growth over time due to unfavorable foreign exchange conversions.
“This typically drives a wider range of performance outcomes across the index during reporting season and fosters a robust stock picking environment,” Wilson added. “We see such an outcome playing out this earnings season alongside a mid-single-digit EPS beat rate at the index level.”
Per FactSet data, S&P 500 companies with international exposure drove the bulk of earnings growth during the third quarter, a troubling indication that any weakness on the forex front could bleed into overall stock market performance.
The greenback’s positive price action has largely been driven by two main catalysts: Trump’s election and the subsequent Republican sweep, along with the recalibration of future Fed easing in the face of strong economic data.
After hitting a September low, the US Dollar Index, which measures the dollar’s value relative to a basket of six foreign currencies (the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc), has rallied 10%. Since the election, it has climbed by over 6%.
Given those moves, “our analysis shows that we should see an uptick in mentions of currency impact this earnings season,” Wilson said.
Trump’s proposed policies, which include high tariffs on imported goods, tax cuts for corporations, and curbs on immigration,have led to more bullishness around the dollar, largely due to their protectionist nature.
And with most economists in agreement that the bulk of those policies, especially Trump’s tariff plans, will lead to higher inflation over time and force the Fed to keep rates higher for longer, the cycle surrounding bullish dollar sentiment remains intact.
“Looking ahead, the critical questions are to what extent these moves [in the dollar index] will be validated by the incoming data, and whether they already incorporate our expectations for policy shifts in the coming year, particularly higher tariffs,” Goldman Sachs research team, led by analyst Kamakshya Trivedi, wrote in a separate note on Friday.
The team predicted the dollar would rise by another 5% over the coming year, noting upside risks are not fully priced in.
“While we acknowledge that [foreign exchange] market participants are clearly expecting some degree of tariff policy changes, and it is difficult to disentangle the drivers of recent moves, we maintain that there is more dollar strength ahead.”
With more strength expected, Morgan Stanley’s Wilson said earnings momentum “looks less strong” for consumer goods companies, adding tariff risks remain an overhang for valuation. He prefers the services sector, “as earnings revisions are strengthening across travel, leisure, media, and experiences.”
Still, it’s possible multinational companies report strong earnings based on domestic demand despite currency impacts. In that case, stocks may still hold up well.
“S&P 500 performance can be quite resilient during stronger dollar periods as long as robust domestic growth is the main driver of dollar upside,” Wilson said.
“Bottom line, a stronger dollar is typically not a key variable in terms of explaining index EPS growth/performance over time though it can be an important factor for stocks with high foreign revenue exposure.”
Alexandra Canal is a Senior Reporter at Yahoo Finance. Follow her on X @allie_canal, LinkedIn, and email her at [email protected].
Click here for the latest stock market news and in-depth analysis, including events that move stocks
Read the latest financial and business news from Yahoo Finance
