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The downside of a rising dollar
After last year's slide, dollar's 2005 rally is helping U.S. travelers, hurting some U.S. firms.
July 11, 2005: 4:13 PM EDT
By Chris Isidore, CNN/Money senior writer

NEW YORK (CNN/Money) - The surprise rally in the dollar this year is great news if you're planning a trip overseas -- unless it's on a sales trip.

With the dollar near a 14-month peak against the euro and higher against the yen, this is a better time to try to travel or buy goods overseas. A euro was worth $1.2066 in trading late Monday, which means the dollar has gained 11 percent from when the euro hit a record $1.3664 on Dec. 30.

So an Italian hotel room at $270 a night or dinner at a fancy French joint that might have cost you the same six months ago costs $30 less today, even if the price in euros hasn't changed.

But U.S. businesses could find it tougher to make sales overseas because a rising dollar makes American goods less competitive in other countries.

The dollar spent the last half of 2004 falling sharply against both currencies, a fact that helped lift U.S. exports to record levels earlier this year and allowed some companies to record stronger-than-expected sales for 2004.

But as second-quarter earnings season begins, investors could start to see some of the downside from a higher dollar.

Software provider Oracle Corp. (Research) warned investors earlier this month that its revenue for the current fiscal year, which ends May 31, 2006, will be off about 2 percent due to changes in currency exchange rates. It likely won't be the last company to adjustment to its outlook.

"I don't expect consumers here will really see a 10 percent movement on the prices of imported goods," said University of Maryland Professor Peter Morici. "But for exporters, that 10 percent is very real."

But the overall impact on U.S. corporate earnings is likely to be limited, said Mike Thompson, director of research for Thomson Financial. Many of the multinational companies have long-term currency contracts, or hedges, to protect them against such changes in exchange rates, he said.

"Most of these companies don't want to have the fluctuations, good or bad," said Thompson. "When we saw the weakening dollar, it was a boon for companies like Coca-Cola (Research). But most companies hedge against the adverse scenario of a stronger dollar."

Another hit against exports could come as economies in Europe and other countries slow, according to the experts. The weaker economic outlook overseas is one of the reasons for the strengthening of the dollar in 2005.

"With our trading partners slowing down, they're not going to demand a lot of exports from us," said Ashraf Laidi, chief currency analyst for MG Financial Group.

A survey of executives at manufacturing firms by the Institute of Supply Management found only 12 percent reporting more export orders in June than in the previous month. That's about half of the 23 percent who reported improved export orders in the April survey.

Laidi said even more than the difference in economic outlook between the United States and other developed countries, the difference in interest rates is driving the dollar higher.

While the Federal Reserve is raising interest rates at home, the European Central Bank has been holding rates steady, and there have been calls for cuts to spur the economies there. He said that many experts wrongly predicted a further slide in the dollar in the first half of 2005, because they did not expect the growing interest rate gap. Higher domestic rates tend to make U.S. investments more attractive to investors overseas -- and hence boost demand for dollars.

"The market got so fooled because the traders underestimated the Fed's positive assessment of the economy and its insistence to increase interest rates," he said.

Also pushing the dollar higher were votes in France and the Netherlands in late May and early June, rejecting the proposed European constitution. While neither vote meant that either nation would stop using the common European currency, it raised worries about the euro among currency traders.

"Markets always have a tendency to overreact when they have news," said Laidi.

Of course, some U.S. businesses will see benefits from the stronger dollar. It's a lift to businesses buying raw materials, especially commodities, from overseas. They'll likely see a decline in prices paid for those raw materials.

But the lower commodity prices are also bad news for U.S producers of those products, such as steel, since they now face greater competition from overseas suppliers.

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