Navigating the Financial Landscape: Global Markets and the Influence of Central Banks

Navigating the Financial Landscape: Global Markets and the Influence of Central Banks

Fluctuating Markets: Stocks, Bonds, and the US Dollar

Global financial markets experienced subtle shifts as a busy week for major central banks kicked off. Decisions pertaining to interest rates that will impact the global markets for the rest of the year will be made. The Standard and Poor’s 500 Index (S&P 500) closed near 4450 points, while Brent crude saw a decrease in gains after it rose to around $95 per barrel, stoking concerns over inflation.

In individual markets, shares of technology company, Apple, saw an increase. On the other hand, shares of electric vehicle manufacturer, Tesla, declined after a major financial institution downgraded its earnings estimates for the company. Additionally, the yields on 10-year US Treasury bonds declined, while the yield on 2-year Treasury bonds remained stable above 5%.

Eyes on Central Banks: Anticipating Monetary Policy Decisions

Market participants are eagerly awaiting decisions on monetary policy from major central banks, starting with the US Federal Reserve on Wednesday and concluding with the Bank of Japan two days later. Investors broadly anticipate the US Federal Reserve to maintain interest rates, with the focus being on projections for economic recovery. The key questions revolve around whether policymakers will maintain their expectations for another 25 basis point interest rate hike by the end of the year, and the extent of easing they anticipate for 2024.

Depreciating Dollar: Impact on Investments

Since 2020, the value of the dollar relative to other world currencies has been gradually depreciating, a trend that became more pronounced into 2022 as inflation increased. This has implications for both domestic and international investments. A strong dollar typically indicates a robust US economy, low Federal Reserve interest rate increases, and tax policies that incentivize businesses to repatriate profits from abroad. A weak dollar, however, may signal an economic downturn, rising inflation, or a combination of both.

Investors must understand the effect that exchange rates can have on financial statements, how this relates to where goods are sold and produced, and the impact of raw material inflation. The convergence of these factors can help investors decide where and how to allocate investment funds.

Implications of a Falling Dollar: Understanding the Accounting Treatment

In the US, the Financial Accounting Standards Board (FASB) mandates how companies account for business operations on financial statements. The FASB has determined that the primary currency in which each entity conducts its business, referred to as the functional currency, may differ from the reporting currency, resulting in translation adjustments that may lead to gains or losses. These are generally included when calculating net income for that period.

If an investor buys into a company that primarily conducts its business in the US and is domiciled in the US, the functional and reporting currency will be the US dollar. If the company has a subsidiary in Europe, its functional currency will be the euro. When the company translates the subsidiary’s results to the reporting currency (the US dollar), the dollar/euro exchange rate must be used. Therefore, in a falling dollar environment, the company benefits from this translation gain with higher net income.

Profiting from the Falling Dollar: Opportunities for Investors

Investors can take advantage of currency movements in the short term. For instance, they could invest in the currency they believe will show the greatest strength against a falling dollar. Another strategy is to invest in US exporting companies, as a weaker dollar can be beneficial for exporters, making their products relatively less expensive for buyers abroad.

The markets are currently factoring in a 25 basis point rate hike at the upcoming Federal Open Market Committee (FOMC) meeting. Global bond yields are also on the rise. Investors can leverage these trends to make strategic investment decisions, with a keen eye on moves by central banks and the implications of a depreciating US dollar.