Further tariff reductions like the one recently struck with China or an increase in general policy clarity could all buoy U.S. growth prospects and support the currency.
Against a backdrop of shifting tariffs and the rewriting of trade relationships, global currencies have been in flux. Entering 2024 at a two-year high, the U.S. dollar index has since surrendered over 7% of its value against a basket of major currencies. The Euro and Yen, by contrast, have strengthened. With international equities meaningfully outperforming their U.S. counterparts for the first time in decades, many investors are curious about FX prospects. To understand them, it is crucial to examine their drivers.
- Budget and trade balances: Countries that run large budget deficits often run large trade deficits too—if they consume more than they produce, some of that demand must be met externally. These twin deficits are typically currency-negative: they increase the supply of the domestic currency in the global marketplace, weakening its value.
- Interest rate differentials: Higher interest rates in one country compared to another make the higher-rate country's debt more attractive. If this differential narrows, the relative appeal fades. Moreover, rate differentials often reflect economic divergence—a stronger economy tends to support both higher interest rates and stronger equity markets, reinforcing currency strength.
- Government intervention: China has long worked to suppress yuan appreciation to support its export-driven economy—typically by absorbing incoming dollars from trade surpluses and recycling them into U.S. Treasuries. This strategy both props up the dollar and limits the yuan’s rise, even when market forces suggest otherwise. Meanwhile, in the U.S., political rhetoric has increasingly raised concerns about Federal Reserve independence. Undermining confidence in the central bank risks accelerating capital outflows and weakening the dollar.
With these forces in mind, several trends suggest more downside for the dollar: persistent U.S. deficits, a shrinking rate premium and rising concern over policy instability. The growing “Sell America” narrative—rooted in the trade war, fiscal slippage and central bank interference—may add to the pressure.
As a result, it is reasonable to assume that dollar strength has peaked, and to be constructive on international currencies, particularly those in developed markets. For example:
- The Euro may benefit from accelerating local growth, partly fueled by German fiscal expansion. The exit from negative interest rates should support European banks—a key engine of economic performance—while a trade surplus with major partners provides added tailwinds.
- The Yen may find support in positive economic surprises like rising wages and inflation, which give the Bank of Japan room to continue to rate hikes. Still, Japan’s large debt load and export dependency may cap how far that cycle runs—especially if global growth slows.
That said, a dollar rebound is possible: further tariff reductions like the one recently struck with China or an increase in general policy clarity could all buoy U.S. growth prospects and support the currency. As a result, when assessing international equities, investors should not lean on potential currency swings when making allocation decisions. Instead, it would be wise to focus on true local growth.