Morgan Stanley
  • Wealth Management
  • Jul 27, 2020

Why the Dollar Has Weakened and What It Could Mean

The U.S. currency’s recent decline against other major currencies, a long anticipated outcome, could have broad implications across multiple asset classes.

Lisa Shalett Chief Investment Officer, Wealth Management

Understanding the impact of currency fluctuations on corporate performance and stock prices isn’t really Investing 101. But it is an essential component of portfolio construction, especially now that an important shift may be underway. So let’s dive in. 

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After a long period of relative strength against other major currencies, the dollar may finally be losing its luster. The U.S. Dollar Index—a benchmark of value against a basket of key global currencies, such as the euro and yen—peaked on March 20th, but has since fallen 8% through July 24th.

If this dollar weakness persists, it could push up U.S. inflation and press down on equities. That’s why I recommend that investors might want to consider diversifying into non-U.S. equities and commodities, which tend to have an inverse relationship with the dollar, and are consequently experiencing a rally.

This level of macroeconomic analysis can get complicated, but let me sum up three recent catalysts that have contributed to a weaker dollar:

  • Europe and the UK are on the upswing, and so are their currencies. The U.S.’s biggest trading partners are both benefiting from massive fiscal stimulus and relative stability in terms of their coronavirus infection trajectories—something that continues to elude the U.S. I’m particularly encouraged that the EU passed its first joint stimulus plan in July, finally crossing the threshold for the kind of fiscal integration that could lift economic growth in the region and boost the common currency. A related point: With yields on U.S. government debt now close to the level of other developed nations, the global appetite for investing in Treasuries may wane, which would also pressure the dollar.
  • U.S. money supply has grown rapidly. Federal Reserve monetary easing and U.S. fiscal expansion have been unprecedented, following the sudden-stop economic contraction brought about by the pandemic. As I’ve written recently, rapid expansion of debt and deficits serves to debase the dollar in the long run and may lead to inflation.
  • Trade and geopolitical dynamics are shifting. After five years of improvement, the U.S. current account deficit, which measures how much more the U.S. imports than it exports, is growing and could approach 4% of GDP by next year. At the same time, geopolitical tensions are rising and U.S. global leadership has waned, while China’s economic standing continues to rise. This dynamic may lead central banks to restructure their monetary reserves, selling some dollars and potentially buying renminbi. That could also contribute to a weaker dollar.

Given the sudden end of the last business cycle, which featured a strong dollar, and the depth of the current U.S. recession, dollar weakness isn’t surprising. It may not reverse anytime soon. Investors can hedge against their portfolio risk by adding commodities, international equities and emerging-market assets.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Jul 27, 2020, “Finally, A Weaker U.S. Dollar?” Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report.

Risk Considerations

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision. 

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

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