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

“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.” The dollar’s solid performance at the start of 2024 stands in contrast to last year. In 2023, as interest rates appeared to peak in the U.S. but were still rising in other countries, more money flowed out of the U.S. This led to a moderate decline in the dollar’s value versus the euro.¹

The tide may have shifted, at least temporarily, in favor of a stronger dollar. “The dollar’s strength in 2024 reflects that the Federal Reserve (Fed) is making us wait a bit longer for the start of interest rate cuts,” says Haworth. He points out that markets anticipated the Fed scaling back its benchmark federal funds target rate in early 2024, but that timeline appears to be delayed. “Currency markets are, in large part, focused on relative monetary policies of the Fed and other central banks,” says Haworth. “And right now, markets are anticipating that central banks overseas may cut rates before the Fed does so.”

When the dollar gains ground against the euro, as it did in 2024’s early months, goods and services become less expensive for Americans who travel overseas. But from an economic and investment standpoint, the impact is different. For example, a stronger dollar means U.S. goods may be more expensive to purchase overseas, and U.S. company profits from foreign sales will be worth less after converting local currencies to the dollar. Investors may want to consider the role of currency trends when positioning portfolios.

Dollar’s recovery to parity with the euro

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.1 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. “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, 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. However, over the course of 2023 and into early 2024, dollar-to-euro valuations were generally in a trading range between $1.05 and $1.10.¹

Dollar versus other 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. It measures the dollar’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). The index dropped to less than 118 as recently as July 2023 before reaching a 2023 peak of more than 124.00 in late October 2023. The dollar, as measured in the index, again fell below 120 in December 2023 but bounced back in 2024’s first two months.²

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.

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. The impact on the bottom line for companies trading overseas may be limited, however. “They have tools to adjust currency risk, such as locating production facilities in countries where they do business, or using currency hedging strategies to offset any unfavorable currency movements.”

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. Year-to-date through February 2024, the index, in local currency terms, generated a return of 5.78%. However, the net return for a U.S.-based investor in the index, translated back into dollars, was 3.62%. In other words, the stronger dollar resulted in a lower net return for a U.S investor.³ By contrast, when the dollar weakens compared to the euro, it enhances the net return for U.S. investors after the currency exchange.

“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

Haworth says it’s not only relative interest rate policies that may give the dollar an edge in the short term. “The U.S. economy is stronger today than those of most developed countries across the globe. This can also influence currency markets and boost the dollar.” Haworth cautions, however, that varying factors come into play, often on short notice, reflecting the difficulties of trying to predict currency trends.

While currency considerations should not play a decisive role in your investment strategy, 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.

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