We need to talk more about the US Dollar.
Yes, a stronger dollar weakens corporate earnings. But it's also part of the mechanism that funnels capital into the US to drive its huge outperformance vs. the rest of the world.
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
Over the past years, an appreciating US Dollar has been hanging over global financial markets like a menace. And it did in fact coincide with (or trigger?) several market corrections. However, these brief risk-off moments cloud an important truth: The US Dollar strength has been part of the cocktail that has been driving this bull market.
TLDR Summary
In theory, a strengthening US Dollar should be negative for US stock prices. The unit of account gets stronger and it's a burden on corporate earnings from abroad. Empirical evidence supports that hypothesis. There is a statistically significant negative correlation between the US Dollar Index and the S&P 500 for monthly and quarterly returns.
However, the appreciating US Dollar has actually been part of the cocktail that has driven the strong performance of US stocks over the last 15 years, both in absolute terms and in relative terms against the rest of the world.
Since its low in 2008, the US Dollar Index has advanced 50%, particularly by the US Dollar’s appreciation against Yen and Euro. Over the same period, the S&P 500 has quadrupled and outperformed the MSCI World by 130 percentage points. The relative performance is even more remarkable than the absolute performance considering that US companies account for more than two thirds of the global index.
The proliferation of the US technology industry and the domestic energy production boom are certainly two important structural forces to explain this. However, the Fed’s tightening campaign seems to have been the dominant force during the last three years. And this factor is cyclical, not structural.
When the Fed tightens by raising rates and selling securities from their portfolio, they are setting a range of bull market drivers in motion that I don’t think they are fully aware of. Most importantly, they are driving up the Treasury’s deficits which boosts economic growth. This attracts capital from the rest of the world. Everyone wants a piece of the pie that the Treasury is serving under the Fed’s direction. Secondly, monetary tightening supplies low risk assets into markets. Investors digest this by bidding up risk assets to rebalance their portfolios. This creates market momentum that attracts even more capital from abroad.
With a tight Fed, relatively low trade deficits and little credit appetite in the private sector, the Treasury is the only force that supplies cash-like assets into the marketplace which could hurt the US Dollar. But elevated interest rate volatility has made much of their outstanding issuance unsuitable as cash-proxies. This counters the supply increase from deficit spending.
As a result, both US stocks and US Dollars have become hot commodities. With their pitiful attempts of reigning in inflation, the Fed has turned the US into a giant vacuum cleaner for capital from around the world.
The relative gravity of this asset rotation is so strong that it overshadows the negative force from a stronger domestic currency earlier. It’s a flywheel that has propelled the S&P 500 from 4,400 in March 2022 when the hikes began to more than 6,000 in January 2025. Only a fool would think lower rates would exacerbated this bull market even more. As long as high rates persist, this bull market will keep going. It’s aftermath will come with lower rates and a weaker Dollar. And that will surprise most people once again.
What determines FX rates?
The price of anything is determined by how much supply there is vs. demand. Demand for a currency vs. any other currency can come for two reasons. Either people want to transact in the currency, most importantly because they want to buy stuff with it or because they want to hold it for savings and investment purposes. Both of these demand sources can be observed in a country’s balance of payments: