Will A Weaker Dollar Boost Foreign Stock Markets?

The US dollar has been a pillar of strength this year. So far in 2024, the US Dollar Index is up 4.7% through July 1. The rally marks a rebound from last year’s softer dollar. But 2024’s revival may be running out of road, in part because the Federal Reserve is expected to start cutting interest rates later in the year. In that case, the dollar and dollar-based assets may become less appealing, at least on the margins and relative to offshore assets.

A weaker dollar would be welcome change for equities outside the US. The reasoning is straightforward and reflects basic economic logic. All else equal, a stronger dollar translates into fewer dollar-based earnings after translating foreign currencies into greenbacks. The opposite is also true, and so a weaker dollar boosts offshore earnings from a US perspective.

Markets tend to price in this relationship, which means that the dollar’s trend is a key factor that determines the strength of headwinds and tailwinds for global shares outside the US. The chart below highlights this relationship recently, using a pair of ETF proxies: Invesco DB US Dollar Index Bearish Fund (UDN), which falls (rises) when the dollar is weak (strong), and Vanguard Total International Stocks (VXUS). The two funds have a relatively high correlation in recent years but have been diverging this year. Foreign stocks have continued to rally while UDN has been in a trading range. That could be interpreted as a sign that that this year’s dollar rally is set to weaken. See the related research report here.

Another sign that America’s currency may be set to soften relative to its foreign counterparts: moving averages. The 5-week average of the US dollar index has been above its 20-week counterpart since mid-February and remains so through last week’s close (as of Friday, June 28). If and when the 5-week average consistently falls below the 20-week average, that may suggest the start of new period of dollar weakness.