Perhaps the greatest irony of our current economic predicament is that, despite the highest inflation in 40 years, the value of the U.S. dollar (relative to non-U.S. currencies) is the strongest it’s been since 2000. Said differently, while the purchasing power of our dollars at home has declined by 9.1% over the past 12 months1, at the same time the global purchasing power of those same dollars has increased by nearly 15%.2 Consequently, the U.S. trade deficit, as a percentage of GDP, has recently soared to its highest levels in 15 years3, and combined with a sharp decline in the federal deficit, is largely responsible for the Q1’s negative GDP reading. But while the strong dollar bodes well for those travelling abroad or purchasing non-U.S. goods and services, there are also painful downsides to the dollar’s sharp rise. The dollar’s year-to-date strength, for example, is unfortunately weighing heavily on non-U.S. investment returns; nearly half of the -17.2% YTD return on non-U.S. stocks—virtually the same as U.S. stocks4—is due entirely to currency effects (i.e., the strong dollar).5 In other words, had the value of the dollar remained unchanged this year, non-U.S. stock returns would be significantly better than they are now.
It is during such times that investors begin to question the wisdom of global diversification. But we should be careful not to abandon global diversification and certainly not over short-term currency effects. The value of the dollar can naturally move in both directions; just as a rising U.S. dollar detracts from non-U.S. investment returns, a declining U.S. dollar contributes positively to non-U.S. returns. While predicting currency moves is an exercise in futility, there are nevertheless many sound reasons to suspect the U.S. dollar is unlikely to remain at today’s elevated levels in perpetuity. For example, much of the U.S. dollar’s recent rise can be attributed to rising interest rates and the war in Ukraine, neither of which are likely to continue in perpetuity (rising rates and geopolitical tensions increase demand for U.S. dollars and vice versa). To the contrary, market forecasts currently predict U.S. interest rates will peak sometime in early 2023 and will decline slightly thereafter.6 Further, the Fed isn’t the only central bank increasing interest rates; the Bank of England (BOE) raised rates in June and the European Central Bank (ECB) raised interest rates 50 basis points last week—a surprisingly hawkish move and its first rate hike since 2011 (the U.S. dollar subsequently traded lower on the news). Longer-term, the fact that U.S. economic growth is widely expected to significantly lag that of other countries in the years and decades ahead strongly suggests the dollar’s newfound strength is unlikely to last for long.
1 US Bureau of Labor Statistics, Consumer Price Index Summary, July 13, 2022.
2 YCharts, Inc. ICE US Dollar Index (^DXY)
3 JP Morgan Guide to the Markets, July 21, 2022, slide 31.
4 Russell 3000 Index
5 JP Morgan Guide to the Markets, July 21, 2022, slide 47.
6 JP Morgan Guide to the Markets, July 21, 2022, slide 34.
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