Has the U.S. Dollar Been Too Strong for Too Long?
The U.S. dollar has spent nearly a decade in a strengthening trend. After the 2008 Global Financial Crisis, the U.S.’s relative economic and fundamental strengths helped the greenback appreciate against foreign currencies. Then, in response to soaring inflation, the Federal Reserve’s hawkish monetary tightening campaign in 2022 ushered-in even more currency appreciation (see chart below).1
Market participants were anticipating interest rate cuts in late 2023 and throughout 2024, which was supposed to trigger a significant dollar selloff. It hasn’t happened. Instead, inflation remains ‘sticky,’ the Fed has dashed hopes for rate cuts this year, and the dollar has strengthened even further.
U.S. Dollar Relative to Foreign Developed Economies’ Currencies
For context, the dollar is still below its 2022 peak, but it is also just 10% below levels in 1971—when then-President Nixon ended gold convertibility. We also haven’t seen a multi-year stretch of dollar strength like this since the 1980s, when the Volcker Fed had pushed rates into double-digit territory to quash inflation.
When it comes to the relative strength or weakness of the dollar, investors will hear arguments from both sides about the ‘dangers’ of too much strength or too much weakness. A weak dollar raises the cost of imports, reducing the purchasing power of U.S. consumers. A strong dollar threatens Emerging Markets currencies (especially those with large amounts of dollar-denominated debt) and multinationals’ profitability.
But in the current strong dollar environment, we’re not seeing many signs of stress either on multinationals’ earnings results or in the currency markets of foreign developing economies. And if markets are absorbing the impact of a stronger dollar now, I doubt we will see many issues when rates do come down in the U.S.
At the end of the day, what should concern investors is how a strong dollar impacts equity markets. The answer, fortunately, is that there are too many other factors—like earnings and economic growth—driving the equity markets for the dollar to have outsized influence.
The chart below looks at the U.S. dollar relative to foreign currencies (blue line) and performance of the S&P 500 (red line) over the last 10 years. As investors can see, stocks have performed very well during periods when the dollar was weakening (left circle in the chart), and stocks have also rallied when the dollar strengthened substantially (right circle in the chart). The fact that there is no significant correlation historically between dollar strength or weakness and market returns tells us we should be focused on other fundamentals when making investment decisions.
The U.S. Dollar vs. Foreign Currencies (blue line, left axis) and S&P 500 (red line, right axis)
Bottom Line for Investors
The U.S. dollar has been strong relative to foreign currencies for years now, and 2024 has seen continued strengthening. While that trend has some market participants worried, the reality is that stronger or weaker dollars create both winners and losers, which makes neither inherently positive or negative.
Among the winners during strong dollar regimes are U.S. consumers, and also businesses that rely heavily on imports in order to drive domestic sales. Americans can stretch the value of the dollar when traveling overseas and/or buying goods and services from abroad, and businesses that rely on imports may see some input cost relief given that the dollar goes further.
To the extent that a strong dollar affects earnings, individual stocks can feel an impact. But broadly speaking, the stock market has done very well when the dollar was strengthening and weakening, and vice versa. There is no significant correlation between the two. A strengthening dollar historically corresponded with one of the best periods for stocks, 1995 – 2000, but also one of the worst: the 2008 bear market. At the same time, the dollar’s weakening period from 2003 – 2006 did not adversely impact the economic expansion and stock market recovery then, just like a strong dollar is not likely to shift the economy or market’s direction now.
In addition to the dollar, many investors are wondering how the upcoming election will impact the market’s direction. Perhaps more than usual, this election is generating strong opinions coming from every part of the political spectrum, and emotions are running high.
Disclosure
2 Board of Governors of the Federal Reserve System (US), Nominal Advanced Foreign Economies U.S. Dollar Index [DTWEXAFEGS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DTWEXAFEGS, June 12, 2024
3 Board of Governors of the Federal Reserve System (US), Nominal Advanced Foreign Economies U.S. Dollar Index [DTWEXAFEGS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DTWEXAFEGS, June 12, 2024.
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