One of the strongest rallies for the U.S. dollar in the last 20 years appears to have finally lost its steam. For the month of November, the U.S. Dollar, as measured by the ICE U.S. Dollar Index (DXY), fell by a little over 5%. This downward move marked the largest monthly percentage decline since July 2010. The decline comes as investors now see increasing chances that the Federal Reserve’s (Fed) aggressive interest rate policy is working to tame inflation as the most recent inflation reports show signs of cooling. Moreover, Fed officials commented in the previous weeks that they support slowing down the pace of rate increases.
While the DXY remains at elevated levels, there are signs that the safe haven asset is losing its attractiveness as investors see not only see cooling inflation in the U.S. but also a rosier outlook for global growth going forward. Typically, investors look at the U.S. dollar during periods of market turmoil as it is considered a safe investment. This was the case during the onset of the pandemic, but as global interest rates were cut the DXY fell as investors looking for yield saw better opportunities. However, that aspect quickly turned in 2022 as the U.S. began its interest rate increases, making U.S. yields relatively more attractive. Consequently, the strong rally in the U.S. dollar has not been a welcomed move by all.
The rally has caused strong headwinds for U.S. companies and international and emerging market economies. On one end, U.S.-based companies lose out with a dollar rally as the revenues they generate globally are impacted when they need to convert those sales in the foreign currency back to U.S. dollars. On the other end, the slightly weaker dollar is a welcome sight for international and emerging market economies as their currencies begin to gain some strength, and more so for those emerging economies that need to borrow in U.S. dollars. The weakening of the U.S. dollar in the past month had a positive impact in international indexes and emerging market indexes as reflected in the chart below.
The recent decline does not necessarily mean that the dollar won’t stay at elevated levels for longer, but it does show that investors are starting to see some semblance of certainty for the year ahead. Going forward, if the dollar continues to lose steam, international and emerging market stocks could continue to benefit to the upside. While U.S. companies could very well look forward to seeing improved competitiveness from a weaker dollar and a lower likelihood that revenues generated abroad are not adversely impacted by currency translation.
Jose Rendon, AIF®
Senior Portfolio Administrator