Goldman's Got Great News For Anyone Who's Freaked Out About The Dollar Rally

Goldman Sachs isn’t worried about the effects of a stronger dollar.

In a note to clients, Goldman Sachs economist Jari Stehn looks at the economic impacts of a strong dollar, which many argue is a negative for stocks and the economy, as a stronger dollar reduces the purchasing power of the US’ international trading partners.

But Stehn writes that under Goldman’s baseline scenario for the dollar, which sees the dollar strengthen another 3% on a broad, trade-weighted basis over the next year, the implications for growth, inflation, and Fed policy are limited.

Stehn writes:

First, the growth effect of a stronger dollar is modest. Specifically, we find that the recent appreciation (if maintained) would lower real GDP growth by about 0.15 percentage point (pp) in 2015 and 0.1pp in 2016. If the dollar continues to appreciate, these growth effects become more significant at 0.25pp in 2015 and 0.3pp in 2016, as the effect of cumulative appreciation builds in outer years.

Second, the inflation effect of dollar appreciation is negligible. Our simulations suggest that the effect of recent dollar strength on year-over-year core PCE inflation will be 0.01pp at the end of 2015 and 0.03pp at the end of 2016. With continued dollar appreciation, the effect is about twice as large. The intuition for a very small effect on inflation is that inflation in FRB/US depends primarily on the level of slack in the economy, not the growth rate of output.

Finally, the implications of a stronger dollar for the Fed are limited. Under an inertial Taylor rule, the dollar appreciation observed to date (if maintained) would lower the warranted funds rate by 5 basis points (bp) at the end of 2015 and 15bp at the end of 2016. Continued dollar appreciation would, again, lead to somewhat larger effects.

These three charts from Goldman illustrate the firm’s expected — and somewhat muted — impacts of a strong dollar.

Now, the important caveat is that if the dollar appreciates more than Goldman currently expects, these effects will be amplified, especially over the longer-term.

This past weekend, RBC Capital’s Jonathan Golub wrote that, “Conventional wisdom holds that a stronger exchange rate is likely to be a headwind for stocks as US products become less competitive abroad. Our research suggests this is not the case: (1) the economy and the dollar tend to move in tandem, which means that a stronger economy should result in dollar strength; (2) a rising dollar is supportive of higher multiples, as shown below.”

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.