What Does the Fluctuating Value of the U.S. Dollar Mean for Investors? | U.S. Bank (2024)

After the dollar rebounded against the euro and other major currencies in the late summer and early fall of 2023, it retreated in November.¹ Nevertheless, the dollar remains stronger today against the euro than it was before 2022. Foreign investors remain attracted to the dollar today given the U.S. market’s relatively higher interest rate environment.

“Relative currency values reflect the global flow of funds,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “When the dollar strengthens, it means more foreign money is flowing into the U.S. than the other way around.” According to Haworth, the direction of capital flows helps determine the relative strength of a particular currency.

When the dollar loses ground against the euro, as it did in November, goods and services get more expensive for Americans who travel overseas. But from an economic and investment standpoint, the impact is different. You may want to consider the role of currency trends as you position your investment portfolio.

A long recovery for the dollar

As recently as 2008, it took nearly $1.60 to purchase the equivalent of one euro. The dollar has gained significant strength since that time. But as is commonly the case with currency markets, the gradual improvement occurred with a great deal of fluctuation along the way.

Haworth says the interest rate environment and central bank monetary policies play a major role in determining currency movements. He points out that in early 2022, “Thanks to the Federal Reserve’s (Fed’s) decision to raise the federal funds rate quickly, U.S. bond yields in general rose faster than was the case in Europe, and even more so when considering inflation trends.” More attractive real yields (government bond yields less the rate of local inflation) tended to draw more foreign investment dollars, improving the demand for dollars and driving its value higher. In the summer of 2022, the dollar reached parity with the euro ($1 = one euro). For a brief time, less than $1 was required to purchase one euro.

However, by early 2023, it became apparent the Fed would slow the pace of interest rate increases and the European Central Bank (ECB) would implement more dramatic rate hikes. As a result, the dollar weakened against the Euro. “The euro and other currencies became relatively cheap in 2022, which started to attract capital flows,” says Haworth. By July 2023, it cost more than $1.12 to obtain one euro, compared to approximately $1.07 at the start of the year. The dollar recovered some ground between August and October, a time when U.S. bond yields headed higher. In November, the situation reversed, yields rapidly declined and the dollar weakened as a result, though it remained stronger than its July low point.²

Source: FactSet and U.S. Bank Asset Management Group as of November 30, 2023.

Dollar trends consistent across currencies

Trends occurring in the dollar’s relationship to the euro have generally tracked with other currencies as well. One measure of this is the Nominal Broad U.S. Dollar Index. This index, created by the Fed, measures the U.S. currency’s value to a basket of other global currencies, based on their relative importance to U.S. import and export activity.

In late September 2022, the index reached a recent all-time high of 128.32, reflecting significant U.S. dollar strength versus other currencies across the globe. This represented a major jump from the end of 2021, when the index value was 115.40 (signaling a weaker dollar). Its value dropped less than 118 as recently as July 2023 before reaching a 2023 peak of more than 124.00 in late October 2023. The dollar retreated in November to the 120 range.³

Source: FactSet and U.S. Bank Asset Management Group.

It should be noted that currencies fluctuate constantly. Changes are typically minor on a day-to-day basis, but trends may develop with potentially significant implications over time.

The economic impact of currency fluctuations

A positive feature of a stronger dollar is the lower cost of imported products from other countries. For example, if a car made in Germany is valued at €50,000 and then is imported to the U.S. when the dollar stands at $1.20 to €1, the retail price of the car in the U.S. would (theoretically) be $60,000 (20% more than its European price to reflect the currency exchange rate). If the dollar were to appreciate to $0.90 to €1, the car’s value in the U.S., using the same assumptions, would decline to $45,000, a significant savings for a U.S. consumer.

However, a strong dollar can also detract from revenues generated by multinational companies based in the U.S. The net income earned from foreign sales will decrease once exchanged into dollars. A stronger dollar means U.S. companies that export products abroad will be less competitive because the price of the product translated into euros or another currency is higher, which can lead to lower sales as foreign buyers shift to lower cost alternatives.

Investment implications of dollar trends

Corporate earnings can be affected by currency trends. Yet Haworth says the impact of currency movements shouldn’t be a major consideration for investors as they assess the value of specific stocks. The same is not true, however, for U.S. investors who include overseas-based investments in their portfolios.

For example, consider the value of an investment in the MSCI European Union (EU) Index. In 2022, the index, in local currency terms, generated a return of -14.13%. However, the net return for a U.S.-based investor in the fund, translated back into dollars, was -19.97%. In other words, the strong dollar detracted from the return, resulting in an even larger loss during what was an already challenging environment for equities. When the dollar weakens compared to the euro it enhances the net return for U.S. investors after the currency exchange. This was evident using the MSCI EU Index year-to-date through November 30, 2023. In local currency terms, the index returned 13.09%. But after accounting for the currency exchange, the net return for U.S. investors improved modestly to 15.40%.⁴ This reflected the dollar’s weakening value compared to the euro over the course of the year. In the third quarter of 2023, the dollar gained strength, and as a result, reduced net returns after accounting for currency fluctuations.

“Currencies are less volatile than stocks as a whole, and their direction is challenging to predict, given numerous factors that influence relative currency values,” says Haworth. He cautions investors not to base “buy-and-sell” decisions solely on the direction of currency trends.

Future value of the dollar

What direction will the dollar-euro relationship follow next? Haworth notes that currency trends are prominently driven by relative inflation considerations between the U.S. and the locale of another currency, as well as comparative central bank policies.

The Fed’s aggressive interest rates in 2022 helped boost demand for the dollar. Haworth believes markets may be anticipating the Fed will now hold the line on interest rate hikes, then begin cutting rates at some point in 2024. “That could harm demand for the dollar, resulting in weaker dollar performance versus the euro and other currencies.” Yet Haworth points out that other factors may also impact the currency markets. “Weaker global trade activity in recent years has actually been a net positive for the dollar,” says Haworth.

Given the sometimes-unclear root of currency movements, it most likely should not play a decisive role in your investment strategy. However, the issue may be worth discussing with your wealth management professional, particularly if your portfolio includes overseas investments. It can be beneficial to account for the ways currency trends could impact your investments and potentially influence how you choose to allocate assets within in your portfolio in support of your investing strategy.