Investors across the globe have been flocking to the U.S. dollar since mid-2021, pushing some foreign currencies to their lowest levels against the greenback in years.1 But what's behind the dollar's appeal?
"Demand for the U.S. dollar has increased for several reasons," says Kathy Jones, Schwab's chief fixed income strategist. "The United States emerged from the pandemic stronger than many other countries, partly because of aggressive spending and stimulus measures out of Washington. And many investors believe the U.S. will continue to outperform the broader global market in the coming year, thanks to the Federal Reserve's focus on taming inflation."
Meanwhile, the war in Ukraine and China's COVID-19 policies are weighing on Europe and Asia, respectively. "The U.S. dollar is something of a safe haven the world over," Kathy says. "It's backed by the full faith and credit of the U.S. government, and the market for it is broad and deep, making it highly liquid. That's not the case for many currencies right now."
But what does this mean for U.S. investors? It's a mixed bag:
- A stronger dollar makes the costs of imports cheaper. "And that's welcome news right now, particularly given how much we rely on foreign goods," Kathy says.
- However, a strong dollar can also undercut foreign bonds, particularly those from emerging markets. "Over the past decade, a lot of emerging-market countries and companies issued dollar-denominated bonds to attract investors hungry for higher yields," Kathy says. "But with many foreign currencies now struggling against the dollar, it has become much more expensive for issuers to service that debt, leading to a growing risk of downgrades or defaults."
If you're a tactical investor, you might consider cutting back your portfolio's foreign bond allocation in favor of domestic issues for the time being. "But for everyone else," Kathy says, "sticking to your asset allocation and rebalancing regularly should help offset any bumps that result from fluctuations in the dollar's value."
1Karl Russell, Joe Rennison, and Jason Karaian, "The Dollar Is Extremely Strong, Pushing Down the World," nytimes.com, 07/16/2022.
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