Key takeaways

  • The U.S. dollar is rallying against the euro and other major currencies.

  • Higher interest rates are a catalyst for the dollar’s recent gains.

  • Fluctuations in the dollar’s value can affect results for U.S. investors who put money to work in foreign markets.

The dollar rallied against the euro and other major currencies in the late summer and early fall of 2023. This followed an extended period dating back to the closing months of 2022 when the dollar lost ground on the global currency market.1

“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, 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

The dollar’s climb to greater parity with the euro was years in the making. As recently as 2008, it took nearly $1.60 to purchase the equivalent of one euro. The dollar recovered from that point, but with a great deal of fluctuation in value 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, bond yields in general moved higher in the U.S. than in Europe, and even more so when considering inflation.” 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.

“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.”

However, the environment changed in the closing months of 2022. At that point, it appeared the Fed would begin to slow the pace of interest rate increases. At the same time, the European Central Bank (ECB) began to implement more dramatic rate hikes. “It all comes back to relative differences in central bank policy, economic growth, cash interest rates and inflation between two countries or the U.S. and a region like the eurozone,” says Haworth. “The euro and other currencies became relatively cheap in 2022, which started to attract capital flows.” By mid-April 2023, the dollar stood at approximately $1.10 to the euro, a slight weakening from where it started the year. The dollar recovered some ground in August and September 2023, moving up to just under $1.06 to the euro.2

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


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 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 to 118 as recently as July 2023 before jumping to 122.77 at the end of September 2023.3

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 June 29, 2023. In local currency terms, the index returned 13.12%. But after accounting for the currency exchange, the net return for U.S. investors improved modestly to 15.41%.4 This reflected the dollar’s weakening value compared to the euro during that period. 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. While Haworth believes it’s important for investors to be aware of how currency trends may impact investment returns, he warns not to base “buy-and-sell” decisions solely on those 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.

For most of 2022, the Fed was far more aggressive than the ECB in raising short-term interest rates. As a result, U.S. fixed income investments paid more attractive yields than those offered by European markets. This pushed more investors into U.S. Treasuries, boosting demand for the dollar. Now the situation may be changing, according to Haworth. “The Fed appears near a peak in this interest rate cycle, while the ECB still likely has more work to do and the Bank of Japan has yet to begin raising interest rates.” That could be an indication of potential weakness for the dollar going forward, though other factors may also come into play.

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.

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  3. Source: Federal Reserve Bank of St. Louis, “Nominal Broad U.S. Dollar Index,” Jan. 31, 2023.

  4. Source: MSCI “End of day index data search.”

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