With the many headlines in the investing news, one key factor we watch is the value of the US Dollar vs other worldwide currencies. The US dollar is the world’s most dominant currency and is used as the primary currency for international trade and investment. Its importance lies not only in its wide usage but also in the fact that many countries peg their currencies to the dollar, and it is the reserve currency of many central banks. As a result, the US dollar has a significant impact on the global economy and financial markets, including investments.
- Currency exchange rates: A strengthening US dollar means that it can buy more foreign currency than before. This can make it cheaper for US investors to buy foreign assets, such as stocks or bonds, denominated in foreign currencies. On the other hand, it can make it more expensive for foreign investors to buy assets denominated in US dollars, such as US stocks or bonds.
- Commodity prices: A stronger US dollar can also affect the prices of commodities, such as oil, metals, and agricultural products, which are often priced in US dollars on international markets. A stronger dollar can make these commodities cheaper for buyers using other currencies, which can decrease demand and potentially lead to lower commodity prices.
- International investments: A strengthening US dollar can also affect the returns on international investments. For example, if an investor from another country buys a US-listed stock and the US dollar strengthens against their domestic currency, the investment may still go up in value, but the investor may receive a lower return when converting their profits back into their own currency.
Here is a chart that shows the impact of a strengthening US dollar on investment returns using the example of the period from January 2014 to December 2016:
The chart shows the returns of three investments: the S&P 500 (a US equity index), Eurozone equities (measured in USD), and the USD/EUR exchange rate. In this example, the US dollar strengthened against the euro over the period, as indicated by the decreasing USD/EUR exchange rate.
As a result of the strengthening dollar, Eurozone equities had lower returns in USD terms than they would have if the exchange rate had remained constant.
Below is a chart of the US Dollar for the last 10 years, showing an increase of 23.52%. Much of this spike occurred in the last year due to the Federal Reserve’s response to fight inflation by starting a rate hiking cycle.
Markets fluctuate for many reasons, but a key data point is the value of the currency investors are using. The recent weakening in the last couple of months in the US Dollar is something to be aware of as investors make decisions.
|Presented by the Financial Planning Committee of Lake Street, an SEC Registered Investment Adviser
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